Key takeaways
- Before the first payroll you need an EIN, state tax accounts, correct worker classification, and a W-4 from every employee.
- Each payroll moves from hours to gross pay, then deductions and taxes, then net pay.
- Employers match Social Security and Medicare, pay federal and state unemployment tax, and deposit withheld taxes on an IRS schedule.
- Form 941 is due quarterly, Form 940 yearly, and W-2s go to employees and the SSA by January 31.
- Most companies past a handful of employees use full-service payroll to file and deposit taxes for them.
Payroll is the process of calculating what each employee earns, withholding the right taxes and deductions, paying employees, and reporting and depositing those taxes with federal, state, and local agencies. In the US it runs on a fixed schedule and carries strict deadlines.
Most founders run their first payroll with a mix of confidence and dread. The math looks simple. Then the questions start. Is the bonus taxed differently? Do we owe anything to the state where our new remote engineer lives? What is a 941, and did we already miss one?
Payroll is unforgiving because it touches two things people care about deeply: their paycheck and the government's money. Get an employee's pay wrong and you lose trust that week. Get a tax deposit wrong and the penalties arrive months later, often with interest.
This guide lays out the full payroll process in the order you actually do it, so you can run it yourself or check that your provider is doing it right.
Before your first payroll
Setup is where most payroll problems begin, so take it slowly.
- Get an Employer Identification Number (EIN) from the IRS. It is free and you can apply online.
- Register with each state where you have employees. Usually that means a state income tax withholding account, if the state has an income tax, and a state unemployment insurance account. Some cities and counties have their own taxes too.
- Classify every worker correctly. Decide whether each person is an employee or an independent contractor, and whether each employee is exempt or non-exempt from overtime. Our guides on contractor classification and exempt status explain the tests.
- Collect forms. Form W-4 for federal withholding, the state equivalent where needed, Form I-9 for work authorization, and direct deposit details.
- Pick a pay schedule. Weekly, biweekly, semimonthly, or monthly. Many states set minimum pay frequencies, so check yours before choosing monthly.
- Set up workers' compensation insurance, which almost every state requires for employers with employees.
The payroll cycle, step by step
Every payroll follows the same path from hours to net pay.
1. Collect hours and changes
Gather timecards for hourly employees, plus anything that changes pay this period: raises, bonuses, commissions, new hires, terminations, and changes to benefits or tax forms. Late changes are the biggest source of payroll errors, so set a firm cutoff a few days before payday.
2. Calculate gross pay
For hourly employees, multiply hours by the rate and add overtime. Under the Fair Labor Standards Act, non-exempt employees earn at least one and a half times their regular rate for hours over 40 in a workweek. Some states, including California, add daily overtime rules. Nondiscretionary bonuses usually have to be included in the regular rate when you calculate overtime, which trips up a lot of employers.
3. Subtract pre-tax deductions
Traditional 401(k) contributions, pre-tax health premiums under a cafeteria plan, and health savings account contributions typically come out before income tax is calculated.
4. Withhold taxes
Federal income tax withholding is based on the employee's W-4 and IRS Publication 15-T. You also withhold the employee's share of Social Security (6.2 percent, up to the annual wage base) and Medicare (1.45 percent, plus an extra 0.9 percent on wages above $200,000). Then withhold state and local income taxes where they apply.
5. Subtract post-tax deductions
Roth 401(k) contributions, wage garnishments such as child support orders, and some voluntary benefits come out after taxes. Garnishments have federal and state limits and priority rules.
6. Pay employees
Send direct deposits or checks on payday, along with a pay statement. Many states require specific information on pay stubs.
Employer payroll taxes you owe on top of wages
Withholding is the employee's money passing through you. Employer taxes are your own cost, and new business owners often forget to budget for them.
| Tax | Who pays | How it works |
|---|---|---|
| Social Security | Employer and employee | 6.2 percent each, up to the annual wage base set by the SSA |
| Medicare | Employer and employee | 1.45 percent each on all wages; the extra 0.9 percent above $200,000 is employee only |
| Federal unemployment (FUTA) | Employer only | 6.0 percent on the first $7,000 of each employee's wages, reduced by a credit of up to 5.4 percent when state unemployment taxes are paid on time |
| State unemployment (SUTA) | Employer (employee too in a few states) | Rate and wage base vary by state and by your claims history |
| Other state programs | Varies | Some states fund disability or paid family leave through payroll contributions |
Depositing taxes and filing returns
Withheld taxes and employer taxes have to be deposited with the IRS electronically, on a schedule. Most employers are either monthly or semiweekly depositors, based on how much tax they reported during a lookback period. The IRS tells you which schedule applies. Paying late triggers penalties that grow with time.
The main federal filings:
- Form 941 reports wages, withholding, and Social Security and Medicare taxes each quarter. It is due by the last day of the month after the quarter ends.
- Form 940 reports federal unemployment tax once a year, due January 31.
- Form W-2 goes to every employee and to the Social Security Administration by January 31.
- Form 1099-NEC goes to independent contractors you paid above the reporting threshold. Congress raised that threshold from $600 to $2,000 for payments made starting in 2026.
States have their own withholding returns, unemployment reports, and year-end reconciliations, each with its own schedule.
Payroll records you have to keep
The FLSA requires employers to keep payroll records for at least three years and the timecards and wage rate tables used to compute pay for at least two years. The IRS asks employers to keep employment tax records for at least four years. Many states set longer periods. Keeping everything for at least four years is a sensible default, and most payroll systems store it for you.
Payroll mistakes that cost employers the most
- Misclassifying employees as contractors, or non-exempt employees as exempt. Both lead to back taxes or back overtime.
- Forgetting to register in a new state after a remote hire.
- Leaving bonuses out of the overtime regular rate.
- Missing a tax deposit because the business was short on cash. The IRS treats withheld taxes very seriously, and owners can be held personally liable for unpaid trust fund taxes.
- Paying final wages late. Some states require final pay on the last day of work when an employer ends employment.
- Not updating withholding when an employee submits a new W-4.
DIY, payroll software, full-service, or PEO
Running payroll by hand in a spreadsheet is possible for one or two employees, but the risk climbs fast. Most growing companies choose one of these instead.
| Option | What it does | Good fit |
|---|---|---|
| Payroll calculator software | Calculates pay; you file and deposit taxes | Owners with an accountant handling filings |
| Full-service payroll | Calculates, pays, deposits taxes, and files returns | Most small and midsize businesses |
| HRIS with payroll | Payroll plus employee records, benefits, and time in one system | Companies past about 25 employees |
| PEO | Co-employment; the PEO runs payroll under its own tax accounts and adds benefits | Small teams that also want big-company benefits |
Our payroll software buyer guide explains what to look for in each option, and our Gusto vs Rippling and ADP vs Paychex comparisons show how popular providers differ.
Running payroll across several states
The day you hire someone who works in a different state, your payroll gets more complicated, and most of the extra work lands before their first paycheck.
You will usually need to register for withholding and unemployment in the new state, and sometimes for a local tax as well. Income tax is generally owed to the state where the work is performed, but a handful of neighboring states have reciprocity agreements that let employees pay only their home state. Pennsylvania and New Jersey have one. So do Illinois and its neighbors Iowa, Kentucky, Michigan, and Wisconsin. Employees in those situations file a certificate of nonresidence with you, and you withhold for their home state instead.
Unemployment tax works differently. It generally goes to one state per employee, based on where the work is localized, even if the person travels. Pay frequency, final pay timing, and pay stub rules follow the work state too.
If your team is spread across more than three or four states, this is the point where a full-service provider stops being a convenience and starts being the only sane option.
Final paychecks and pay frequency rules
Federal law doesn't set a deadline for final pay. States do, and the differences are sharp. California requires final wages immediately when an employer ends employment, and within 72 hours when an employee quits without notice. Other states allow payment on the next regular payday. Some states also require accrued, unused vacation to be paid out at separation, while others let the written policy decide.
Pay frequency rules are similar. Many states require at least semimonthly pay for most hourly workers, and a few set specific rules for manual laborers or certain industries. Check both rules for every state where you have employees before you pick a schedule or process a termination.
How to fix a payroll mistake
Every payroll team makes mistakes eventually. What matters is how fast and how cleanly you correct them.
If you underpaid someone, fix it quickly with an off-cycle payment rather than waiting for the next run. Some states set deadlines for correcting wage shortfalls, and employees notice when they are short. If you overpaid, talk to the employee before you recover anything. Several states restrict deductions from wages to recover overpayments, and some require written consent. If the error affected taxes in a prior quarter, the IRS uses Form 941-X to correct the earlier return. Whatever happened, write down what went wrong and change the process so it can't happen the same way twice.
Year-end payroll checklist
January is the busiest month in payroll. Get ahead of it in November and December by confirming employee addresses and names match Social Security records, reconciling the year's four Form 941 filings against payroll totals, making sure taxable fringe benefits like personal use of a company car are reported, and confirming contractor W-9 forms are on file before 1099s are due.
Payroll setup and year-end checklist
Work through this list with your team. The printable PDF version has space to tick each item off.
- Apply for an EIN
- Register for state withholding and unemployment accounts in every state with employees
- Check local tax registrations for each work location
- Classify each worker as employee or contractor, and exempt or non-exempt
- Collect Form W-4, state withholding forms, and direct deposit details
- Choose a pay schedule that meets state pay frequency rules
- Set up workers' compensation coverage
- Set a firm cutoff for payroll changes each period
- Include nondiscretionary bonuses in overtime calculations
- Confirm your federal deposit schedule (monthly or semiweekly)
- File Form 941 every quarter
- File Form 940 by January 31
- Send W-2s to employees and SSA by January 31
- Send 1099-NEC to contractors paid above the current threshold
- Keep payroll records for at least four years
Where to go from here
Wherever you are in the process, there is a next step that fits.
Keep reading
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Email templates for this topic
Ready-to-edit emails with subject lines, compliance notes, and a free PDF.
- Bonus announcement email templateAnnounce an individual or company-wide bonus with the amount, timing, and tax details.
- Payroll error correction email templateOwn a payroll mistake, explain the fix, and tell the employee exactly when they will be made whole.
- Pay schedule change email templateAnnounce a change in pay frequency or payday with enough notice and a transition plan.
- Form W-2 availability email templateTell employees and former employees when and where their W-2 is available, with tips to avoid tax season problems.
Frequently asked questions
How much does payroll cost an employer beyond wages?
When is Form 941 due?
Can I run payroll myself?
Do I need to register in another state for one remote employee?
What is the 1099-NEC threshold?
Sources
We checked the facts in this guide against these primary sources. Laws and thresholds change, so confirm current rules before you act.
Written by the HRTally Research Team
Our guides are written and reviewed by people with hands-on US HR, payroll, and HR technology experience. Legal and tax facts are checked against primary sources, such as the Department of Labor, IRS, EEOC, and USCIS, and linked at the end of each guide. Vendors never review or pay for our editorial content.