How to Do Payroll: A Step-by-Step Guide for Small Teams

Running payroll yourself means calculating gross pay, withholding the right taxes and deductions, depositing those taxes on time, and filing the quarterly and annual forms. It starts at hiring: collect a W-4 and I-9 from each new employee, on paper or through onboarding software.

This guide walks through each calculation, the deposit and filing calendar, year-end tasks, and when software or a payroll service is cheaper than doing it by hand.

Calculating withholding and net pay

Federal income tax withholding (using W-4 and IRS Publication 15-T)

Federal income tax withholding is calculated based on the employee's taxable wages, pay frequency, and the instructions on their W-4. IRS Publication 15-T (updated annually) contains the withholding tables.

There are two methods: the Percentage Method (uses IRS tables with a formula) and the Wage Bracket Method (a lookup table by pay period and filing status). Payroll software handles this automatically and updates when the IRS issues annual table revisions.

If you're calculating manually, use Publication 15-T's Percentage Method tables: annualize the employee's wages, subtract the standard withholding allowance from the W-4 step 3 and step 4 adjustments, look up the tax bracket, and apply the formula.

The IRS Tax Withholding Estimator at IRS.gov can verify your calculations for a single employee.

FICA taxes: Social Security and Medicare

FICA (Federal Insurance Contributions Act) taxes fund Social Security and Medicare. Both the employee and employer pay equal shares. Social Security tax: 6.2% on the employee's wages, up to the annual Social Security wage base ($184,500 for 2026 — this adjusts annually).

The employer also pays 6.2%. Once an employee's year-to-date wages exceed the wage base, Social Security withholding stops for the rest of the year. Medicare tax: 1.45% on all wages, no wage base cap. The employer also pays 1.45%.

An additional 0.9% Additional Medicare Tax applies to employee wages exceeding $200,000 in a calendar year — this is withheld from the employee only (no employer match) and begins at the $200,000 threshold regardless of the employee's filing status.

State and local income tax withholding

43 states plus Washington D.C. have a state income tax. Each has its own withholding tables, published in the state's employer withholding guide (updated annually).

To calculate: use the employee's state W-4 equivalent (or the state-specific form), apply the state's withholding tables for the pay period, and remit to the state revenue agency on the state's deposit schedule.

Nine states have no income tax: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. Local income taxes apply in some jurisdictions — notably in Pennsylvania, Ohio, Kentucky, and New York City.

If you have employees in those areas, check for applicable local withholding requirements.

Pre-tax deductions: 401(k), health insurance, FSA/HSA

Pre-tax deductions reduce the employee's taxable wages before most tax calculations run.

Common pre-tax deductions: traditional 401(k) contributions (reduce federal and state taxable wages, but not FICA taxable wages — they are still subject to Social Security and Medicare); health insurance premiums under a Section 125 cafeteria plan (reduce federal, state, and FICA taxable wages); FSA contributions (flexible spending accounts, reduce federal, state, and FICA wages); HSA contributions (health savings accounts, same treatment as FSA if run through payroll).

The tax benefit of pre-tax deductions means an employee contributing $300/month to a health plan doesn't simply lose $300 in take-home pay — they lose $300 minus the combined employee tax rate on that amount (roughly $230–250 depending on their bracket and state).

Post-tax deductions: Roth 401(k), garnishments

Post-tax deductions come out after taxes are calculated and do not reduce the employee's taxable wages. Roth 401(k) contributions are post-tax — the employee pays income tax now in exchange for tax-free withdrawals in retirement.

Wage garnishments (child support orders, creditor garnishments, student loan garnishments, tax levies) are also post-tax deductions. Garnishments are legally mandated: if you receive a garnishment order for an employee, you must withhold and remit the specified amount on schedule or face liability.

Federal law (Consumer Credit Protection Act) limits how much of an employee's disposable earnings can be garnished. Child support orders have a priority over most other garnishments. If you receive multiple garnishment orders for the same employee, follow the federal priority rules.

Net pay calculation

Net pay = gross pay − pre-tax deductions − federal income tax withheld − Social Security tax withheld − Medicare tax withheld − state income tax withheld − local income tax withheld − post-tax deductions.

This is the amount deposited to the employee's bank account or issued as a check. A pay stub must show each item in this calculation separately — gross pay, each deduction with its label, taxes by type, and net pay.

Most states require employees to receive a pay stub (paper or electronic) with each payment. Some states specify the minimum fields that must be included.

Payroll tax deposits and filing deadlines

Withholding taxes from employee paychecks creates a tax deposit obligation. You are holding employee money that belongs to the government — and the IRS tracks whether you're remitting it on the correct schedule.

The deposit schedule is not the same as the filing schedule, and confusing the two is a common source of penalties.

Federal tax deposit schedule: monthly vs semi-weekly

The IRS assigns employers to one of two deposit schedules based on the total tax liability reported in a lookback period (the four quarters ending June 30 of the prior year). Monthly depositors: total taxes reported in the lookback period were $50,000 or less.

Deposit withheld federal income tax and FICA taxes by the 15th of the following month. Semi-weekly depositors: total taxes in the lookback period exceeded $50,000. Deposit by Wednesday for payroll paid on Wednesday through Friday; deposit by Friday for payroll paid on Saturday through Tuesday.

New employers start as monthly depositors. If your total tax liability exceeds $100,000 in any single deposit period, you must deposit by the next business day regardless of your assigned schedule.

Deposit using EFTPS (Electronic Federal Tax Payment System) — bank wire or check is not accepted for federal tax deposits.

Form 941 quarterly filing

Form 941 (Employer's Quarterly Federal Tax Return) reports the federal income tax you withheld and the FICA taxes (both employee and employer share) for each quarter. Filing deadlines: April 30 (Q1: January–March), July 31 (Q2: April–June), October 31 (Q3: July–September), January 31 (Q4: October–December).

If you deposited all taxes on time and in full, the IRS gives you an additional 10 days. Form 941 reconciles what you deposited throughout the quarter against what you owed — any underpayment is due with the filing.

The penalty for failure to file is 5% of the unpaid tax per month, up to 25%.

FUTA (Form 940) annual filing

FUTA (Federal Unemployment Tax Act) funds the federal unemployment system. The FUTA tax rate is 6% on the first $7,000 of each employee's wages per year.

However, if you pay state unemployment tax (SUTA) on time, you receive a credit of up to 5.4%, reducing the effective FUTA rate to 0.6% — meaning the FUTA cost for most employers maxes out at $42 per employee per year ($7,000 × 0.6%).

Form 940 is filed annually, due January 31 (or February 10 if all deposits were made on time). If your FUTA liability exceeds $500 in any quarter, you must make a deposit by the last day of the following month.

FUTA is an employer-only tax — do not withhold it from employee wages.

State payroll tax deadlines by state type

State payroll tax obligations include state income tax withholding remittance and state unemployment insurance (SUTA) contributions. Deposit frequency varies by state and by your total liability — states typically assign monthly, quarterly, or accelerated schedules.

SUTA rates vary significantly: new employer rates in 2024 range from under 1% to over 3% depending on the state, and rates adjust annually based on your unemployment claim history. States with no income tax still require SUTA registration and quarterly reporting.

State filing deadlines are separate from federal deadlines — maintain a calendar that tracks both.

Key state-specific notes: California has accelerated deposit requirements (next business day) for large employers; New York requires semi-weekly deposits for employers with a quarterly withholding liability over $100,000; Texas has no income tax but still requires quarterly TWC (unemployment) filings.

Year-end payroll tasks

Year-end is the most compliance-dense period in the payroll calendar. The tasks below must be completed in a specific sequence — errors discovered after W-2s are distributed require W-2c corrections, which are time-consuming and create employee confusion.

W-2 preparation and distribution (by January 31)

Form W-2 reports each employee's annual wages and withheld taxes. The deadline to furnish W-2s to employees is January 31. The same January 31 deadline applies to filing Copy A with the Social Security Administration (SSA).

Filing late with the SSA triggers penalties ranging from $60 to $310 per form depending on how late the filing is.

Before generating W-2s: verify year-to-date totals for every employee match your quarterly 941 filings; confirm all pre-tax deductions are coded correctly in Box 12 (401k contributions go in Box 12 Code D; HSA contributions in Box 12 Code W); verify that third-party sick pay is included if applicable; confirm that group-term life insurance over $50,000 is included in taxable wages.

If any employee moved during the year, use their current address. Employees can consent to receive W-2s electronically, but must opt in — you cannot default to electronic-only without consent.

1099-NEC for contractors

Form 1099-NEC (Nonemployee Compensation) is required for any independent contractor you paid $2,000 or more during the calendar year (for payments made in 2026 and later; the threshold was $600 through 2025).

The deadline matches W-2s: January 31 to furnish to the contractor and to file Copy A with the IRS. Before year-end, verify you have a completed Form W-9 on file for every contractor you've paid — the W-9 provides the contractor's TIN (tax identification number) needed for the 1099.

If you don't have a W-9 and cannot obtain one, you may be required to apply backup withholding at 24% on future payments. Common mistake: misclassifying employees as contractors.

If the IRS reclassifies a contractor as an employee, you owe all back employment taxes plus penalties and interest.

Reconciliation and annual reporting

Before closing the year, reconcile: total wages on all four Form 941s must equal total wages on all W-2s (plus any wages for terminated employees).

Total federal income tax withheld on 941s must match Box 2 totals across all W-2s. Total Social Security and Medicare wages on 941s must match W-2 Box 3 and Box 5 totals. If you use payroll software, these reconciliations are generated automatically.

If you run payroll manually, build a reconciliation spreadsheet that tracks cumulative totals by quarter. Discrepancies between 941 filings and W-2 totals generate IRS notices — catching them before filing prevents a cascade of correction paperwork.

New payroll setup checklist

• Apply for EIN at IRS.gov (free, immediate issuance)
• Register for state employer withholding account in each state where employees work
• Register for state unemployment insurance (SUTA) account in each state
• Enroll in EFTPS (Electronic Federal Tax Payment System) for federal tax deposits
• Determine federal deposit schedule (monthly for new employers)
• Set pay frequency and document the pay schedule for the year (all pay dates, 12 months forward)
• Collect W-4 and state withholding form from every employee before first payroll
• Complete I-9 verification for every employee within 3 business days of start date
• Collect direct deposit authorization from all employees
• Collect W-9 from every independent contractor before first payment
• Set up payroll software or spreadsheet with all employee data: name, SSN, address, pay rate, filing status, deduction elections
• Enroll in state new-hire reporting portal (required in all 50 states)
• Create a payroll calendar with all pay dates, deposit deadlines, and quarterly filing deadlines for the year

Per-payroll run checklist

• Collect and verify timesheets or hours for all hourly employees
• Identify any pay rate changes, new hires, or terminations since last payroll
• Calculate gross pay for each employee (hours × rate for hourly; salary ÷ pay periods for salaried)
• Apply overtime rules — check for hours over 40 in the workweek (or over 8/day in CA)
• Apply pre-tax deductions (401k, health insurance, FSA/HSA) in correct amounts
• Calculate and withhold federal income tax using current W-4 and IRS tables
• Calculate employee Social Security (6.2%) and Medicare (1.45%) — flag anyone near the SS wage base
• Calculate employer FICA match (6.2% SS + 1.45% Medicare)
• Apply state and local income tax withholding per applicable tables
• Apply post-tax deductions (Roth 401k, garnishments) in correct amounts and priority order
• Review net pay for each employee — flag any amounts that look unusually high or low
• Approve and submit payroll (or process direct deposits) by the required cutoff
• Confirm federal tax deposit is scheduled via EFTPS by the applicable deadline
• Confirm state tax deposit is scheduled per state deposit schedule
• Generate and save payroll register and pay stubs for your records

Payroll software vs doing it manually vs hiring a payroll service

Every small business eventually has to decide: run payroll in a spreadsheet, use payroll software, or hand it to a service. Each option has a real cost — not just the subscription fee, but the time cost and the error rate.

A study by the American Payroll Association found that manual payroll processing has an error rate of approximately 1–8%, and the average cost of correcting a single payroll error is $291.

When to use payroll software (Gusto, ADP, Paychex, Rippling)

Payroll software is the right choice for most small businesses with 1–200 employees that have reasonably straightforward US payroll.

The software handles all calculations, generates pay stubs, files and remits taxes automatically (on most plans), and generates year-end W-2s and 1099s. Gusto is the most commonly recommended platform for small businesses — it includes automatic tax filing in all plans, strong benefits administration integration, and a clean UI that non-payroll specialists can operate.

ADP Run and Paychex Flex are better-suited to businesses that expect to scale or need HR module integration. Rippling combines payroll with IT device management and HRIS in a single platform — a strong fit for tech companies.

Monthly cost benchmarks: Gusto starts at $49/month + $6 per person; ADP RUN is quote-based, estimated from about $79/month + $4 per employee; Rippling is estimated at about $35–40/month + $8 per employee for its core platform, with payroll extra.

When a payroll service or PEO makes sense

A full-service payroll provider (or Professional Employer Organization) makes sense when: your payroll has high complexity (multi-state, international, multiple legal entities, union agreements, or frequent off-cycle payments); your HR team lacks payroll expertise and you need guaranteed accuracy with someone else's liability; or you want to offer benefits that would be cost-prohibitive to negotiate on your own.

A PEO co-employs your workforce, giving you access to large-group benefit rates and taking on employer compliance responsibilities. ADP TotalSource, TriNet, Justworks, and Rippling PEO are the leading options. TriNet vs Rippling shows how a traditional PEO and a software-first one differ.

PEO admin fees typically run about $60–200 per employee per month ($720–2,400 per year), per PEO Clarify's April 2026 benchmarks, which is appropriate for companies where the compliance risk or benefits cost savings justify the premium.

True cost comparison: DIY vs software vs full-service

For a 10-person company running biweekly payroll: DIY manual processing takes approximately 5–8 hours per pay period for a non-expert, plus 20+ hours at year-end — at $40/hour loaded cost, that's roughly $5,000–7,000 per year in staff time alone, before penalties.

Payroll software (Gusto at $49/month + $60/month for 10 employees at $6/head) costs $1,308/year and reduces processing time to 30–60 minutes per run, for a total time cost around $600–800/year, making the all-in cost approximately $1,900–2,100/year.

A full-service payroll provider charges $150–200/month for 10 employees ($1,800–2,400/year) and handles everything including tax filing — but you lose real-time visibility and control. The arithmetic strongly favors payroll software for most companies under 100 employees.

Common payroll mistakes and how to avoid them

The IRS assessed $7 billion in employment tax penalties in a recent filing year. Most payroll mistakes fall into a small number of recurring categories — knowing them in advance is most of the defense.

• Missing federal tax deposit deadlines — set EFTPS reminders aligned to your deposit schedule, not just pay dates
• Using the wrong deposit schedule — re-check your lookback period each November for the upcoming year
• Failing to withhold Additional Medicare Tax on wages over $200,000 — set a year-to-date wage alert in your payroll system
• Miscalculating overtime — verify your workweek definition is consistent and documented; review daily overtime rules in CA, AK, NV
• Worker misclassification (1099 vs W-2) — when in doubt, use the IRS 20-factor test or consult an employment attorney before classifying as contractor
• Forgetting to register in new states when employees relocate — address changes in your HRIS should trigger a state registration review
• Missing state new-hire reporting after each hire — most payroll software handles this automatically; if manual, report within 20 days
• Failing to update W-4 withholding when employees submit new forms — process W-4 updates for the first payroll after receipt
• Not reconciling quarterly 941s to W-2 totals before year-end — run the reconciliation in November, not January
• Distributing W-2s after January 31 — build the year-end timeline backward from January 31 and start the reconciliation in early January

Frequently asked questions about running payroll