US Payroll Basics for Small Employers

Payroll Last reviewed 2 September 2026 · 8 min read

Paying someone in the United States is not the same as paying them. Between the gross figure you agree and the money that reaches their account sits a set of withholding, matching and reporting obligations that belong to you as the employer — and the penalties for getting them wrong are among the least forgiving in US tax.

First: employee or contractor?

Everything downstream depends on this, and it is the single most consequential decision in this guide.

• An employee receives a Form W-2. You withhold income tax and payroll taxes from their pay, you pay the employer's share on top, and you file returns through the year.

• An independent contractor receives a Form 1099-NEC where the reporting threshold is met. You withhold nothing and you pay no employer taxes.

The second is obviously cheaper and simpler, which is precisely why the IRS scrutinises it. The classification is not yours to choose. It is determined by the actual working relationship — how much control you exercise over how, when and where the work is done, how the person is paid, whether they are free to work for others, and how permanent the arrangement is.

What you withhold, and what you match

For an employee, three things come out of gross pay:

• Federal income tax, at a rate based on the Form W-4 the employee completes.

• Social Security tax, which applies up to an annual wage cap that is adjusted each year.

• Medicare tax, which has no cap, plus an additional Medicare amount on higher earnings.

Social Security and Medicare are collectively FICA, and the employer matches the employee's share — it is a cost to you, not merely a deduction from them. Employers also pay federal unemployment tax (FUTA), and state unemployment tax at a rate that varies by state and by your own claims history.

Then there is state and, in some places, local income tax withholding, which depends on where the employee works — not where your company is registered.

The trust fund rule

This deserves its own heading because it is the thing that ruins small employers.

Money withheld from an employee's pay is not your company's money. It is held in trust for the government. If a business gets into difficulty and uses withheld payroll taxes to cover other costs — which is exactly what a cash-strapped business is tempted to do, because the money is sitting right there — the consequences are severe.

The IRS can pursue the individuals responsible personally for the withheld amounts. Not the company. The people who decided. Limited liability does not shield you from it, and it survives the company's insolvency.

Deposits and returns

Payroll taxes are not paid annually. They are deposited on a schedule — semi-weekly or monthly depending on your history — and reported separately:

• Form 941, filed quarterly, reporting wages and the federal taxes withheld and matched. Smaller employers may qualify to file annually on Form 944 instead.

• Form 940, filed annually for federal unemployment tax.

• Form W-2 to each employee after year end, with copies filed with the Social Security Administration.

• State returns, on each state's own schedule.

Deposit penalties escalate with lateness, so a deposit made a few days late is treated very differently from one made a month late.

Registrations before the first payslip

Before you can run payroll at all you need, at minimum:

1. an EIN for the company;

2. a state withholding account in each state where an employee works;

3. a state unemployment insurance account, usually separate from the withholding account;

4. workers' compensation insurance, which most states require;

5. a completed Form W-4 and Form I-9 for each employee.

A remote employee creates obligations in their state. Hiring one person in a new state generally means registering in that state, whatever your company's own address says.

If you are hiring into the US from abroad

A foreign-owned US company hiring US staff has the same obligations as any other US employer — being run from India changes nothing about them. Two additional points come up regularly:

• Paying yourself. How an owner takes money out depends on the entity type, and an LLC member's draw is not payroll. Getting this wrong creates problems in both countries.

• Contractors outside the US. Paying a non-US person for work performed outside the US has different reporting from paying a US person, and generally involves collecting a Form W-8 series certificate rather than a W-9.

Note: This guide is general information about US payroll obligations. Rates, caps, thresholds and state requirements change and vary by jurisdiction. Please confirm the position that applies to you before running payroll.