US payroll explained for small businesses
Reviewed by Mellow Editorial Team, HR & payroll content team
Running US payroll means calculating each employee's gross pay, withholding the correct federal, state, and local taxes, remitting those taxes on a set schedule, and filing the required reports — all on time, every time.
What you're responsible for as an employer
When you hire someone as a W-2 employee (not a contractor), you take on several obligations:
- Withhold federal income tax based on each employee's Form W-4 elections
- Withhold the employee share of FICA taxes
- Pay the employer share of FICA taxes out of your own pocket
- Withhold any applicable state and local income taxes
- Remit everything to the IRS and relevant state agencies on schedule
- File the required reports each quarter and at year-end
None of these are optional. Getting any one of them wrong can trigger penalties, back taxes, and interest.
Setting up withholding correctly
Before you run a single payroll, every new hire completes a Form W-4. This tells you how much federal income tax to withhold from each paycheck. Federal income tax is progressive, with brackets running from 10% to 37% depending on taxable income and filing status. The W-4 is not a set-and-forget document — employees can update it whenever their situation changes, and you must apply any new version from the next payroll run onward.
FICA withholding is more straightforward because the rates are fixed. You withhold Social Security tax at 6.2% of the employee's wages up to the annual wage base, and Medicare tax at 1.45% with no cap. You then match both of those amounts yourself. If an employee earns above the IRS threshold for high earners, an additional 0.9% Medicare surcharge applies to the employee's wages only — you do not match that piece.
State income tax depends entirely on where your employees work. Some states — Texas, Florida, and Washington among them — impose no state income tax. Others have their own withholding forms and rate structures. If you have employees in multiple states, you manage each state's rules separately.
Running each payroll period
A typical payroll run follows the same sequence every time:
1. Calculate gross pay. For salaried employees that's straightforward. For hourly workers, multiply hours by rate and add any overtime. Under the Fair Labor Standards Act, non-exempt employees are entitled to overtime for hours over 40 in a workweek.
2. Apply pre-tax deductions. Health insurance premiums, 401(k) contributions, and similar benefits often reduce the taxable wage before you calculate withholding.
3. Withhold taxes. Federal income tax (per the W-4), Social Security, Medicare, and state and local taxes as applicable.
4. Apply post-tax deductions. Wage garnishments, Roth contributions, and some voluntary deductions come out after tax.
5. Pay the employee. Direct deposit is the most common method. Net pay is gross pay minus all deductions and withholdings.
6. Remit withheld taxes. Federal deposits go through the Electronic Federal Tax Payment System (EFTPS). Most small businesses are monthly depositors initially, but the IRS can require semi-weekly deposits based on your prior-year tax liability.
Filing requirements and deadlines
US payroll generates a recurring stack of reports. Missing a deadline costs money, so it is worth building these into your calendar before they sneak up on you.
Form 941 — the Employer's Quarterly Federal Tax Return — is due at the end of the month following each quarter (April 30, July 31, October 31, January 31). It summarizes wages paid, federal income tax withheld, and FICA taxes for the quarter.
Form W-2 must be sent to each employee and filed with the Social Security Administration by January 31 of the following year. Employees use it to file their personal tax returns.
Form 1099-NEC covers independent contractors rather than employees. If you paid a contractor $600 or more during the year, you file a 1099-NEC and provide a copy to the contractor, also by January 31.
FUTA — the Federal Unemployment Tax Act — requires a separate annual filing on Form 940, due January 31. You also make FUTA deposits throughout the year if your liability exceeds the IRS threshold.
Common mistakes to avoid
A few errors come up repeatedly with small business payroll:
Misclassifying workers. Treating an employee as an independent contractor to avoid FICA and withholding obligations is one of the most expensive payroll mistakes you can make. The IRS uses a behavioral and financial control test to assess the relationship, and retroactive reclassification can include back taxes, penalties, and interest going back years.
Missing deposit deadlines. The penalty for late federal tax deposits starts at 2% and scales up the longer the payment is overdue. Automating deposits through EFTPS removes most of the risk.
Ignoring state-specific rules. State payroll law goes beyond income tax. States set their own unemployment insurance rates, may require additional withholding forms, and sometimes mandate paid leave programs funded through payroll deductions — California being one notable example. If you're managing a distributed team across several states, the compliance surface is wider than many employers expect. How Mellow runs payroll across six countries covers how multi-jurisdiction payroll can be structured more efficiently.
Forgetting year-end reconciliation. Before you file W-2s in January, reconcile your total wages paid and taxes withheld against your four quarterly 941 filings. Discrepancies between those numbers will draw IRS attention.
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