How to Run Payroll for a Small Business
How small business payroll works step by step, including withholding, 2026 tax rates, IRS deposit schedules, quarterly and annual filings and what payroll software automates for you.
To run payroll, calculate each employee's gross pay, subtract federal and state income tax withholding, Social Security, Medicare and any deductions, then pay the net amount. Deposit withheld and employer taxes on your IRS schedule, file Form 941 each quarter and Form 940 each year, and give employees W-2s by January 31. Payroll software automates most of this.
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Payday is the one deadline you can’t miss. Employees expect the right amount in their account on time, and the IRS expects the taxes you withheld to arrive on schedule too. Get either wrong and you face unhappy staff, penalties or both.
Running payroll isn’t complicated once you understand the pieces: gross pay, withholding, employer taxes, deposits and filings. This guide explains each step, the 2026 federal numbers, the deposit schedules that trip up new employers and what payroll software can take off your plate.
This is general information, not tax or legal advice. State and local rules vary, so confirm details with your accountant or state agencies.
Before your first payroll
If you haven’t hired yet, start with our guide on how to hire your first employee. Before you can run payroll, you need:
- An Employer Identification Number (EIN) from the IRS
- State payroll tax accounts, usually for income tax withholding and unemployment insurance
- A completed Form W-4 from each employee, plus any state withholding form
- Workers’ compensation coverage where required
- A pay schedule, such as weekly, biweekly or semimonthly
- A way to track hours for hourly employees
Make sure each worker is truly an employee. Contractors are paid differently and don’t go through payroll; see 1099 contractor vs W-2 employee.
How a paycheck is calculated
Every paycheck follows the same basic math.
1. Gross pay. Salary for the period, or hourly rate multiplied by hours worked. Under federal law, non-exempt employees must get overtime at 1.5 times their regular rate for hours over 40 in a workweek. Add any bonuses, commissions or tips.
2. Pre-tax deductions. Some benefits, such as traditional 401(k) contributions or certain health insurance premiums, can reduce taxable wages.
3. Tax withholding. Withhold from the employee’s pay: - Federal income tax, based on their Form W-4 and IRS Publication 15-T tables - Social Security tax at 6.2% - Medicare tax at 1.45%, plus an extra 0.9% Additional Medicare Tax on wages over $200,000 in a year - State and local income tax, where applicable
4. Post-tax deductions. Such as Roth retirement contributions, wage garnishments or other after-tax benefits.
5. Net pay. What’s left is the amount you pay the employee.
Your employer taxes
On top of what you withhold, you pay your own share of payroll taxes. Here are the federal figures for 2026 from IRS Publication 15:
| Tax | Employee pays | Employer pays | 2026 wage limit |
|---|---|---|---|
| Social Security | 6.2% | 6.2% | First $184,500 of wages |
| Medicare | 1.45% | 1.45% | No limit |
| Additional Medicare Tax | 0.9% over $200,000 | None | Applies above $200,000 |
| Federal unemployment (FUTA) | None | 6.0%, usually reduced to 0.6% with the state credit | First $7,000 of wages |
| State unemployment (SUTA) | Usually none, varies by state | Rate set by your state | Set by your state |
| Federal income tax | Based on Form W-4 | None | No limit |
The FUTA credit of up to 5.4% applies when you pay your state unemployment taxes in full and on time, which brings the effective FUTA rate to 0.6% for most employers. Some states also require employee or employer contributions for paid family leave or disability insurance.
Key takeaway: Taxes you withhold from employees are held in trust for the government. Never use them to cover cash flow. The IRS can hold owners and other responsible people personally liable for unpaid withheld taxes.
When to deposit payroll taxes
Federal income tax withheld, plus both shares of Social Security and Medicare, must be deposited electronically. IRS Publication 15 says all federal tax deposits must be made by electronic funds transfer, using options such as EFTPS, IRS Direct Pay or your IRS business tax account, or through a payroll provider.
Your deposit schedule depends on your lookback period, which for Form 941 filers is the 12 months from July 1 to June 30 before the current year. For 2026, that is July 1, 2024 through June 30, 2025.
| Rule | Who it applies to | When to deposit |
|---|---|---|
| Monthly | Total taxes of $50,000 or less in the lookback period, including most new employers | By the 15th of the following month |
| Semiweekly | More than $50,000 in the lookback period | Paydays Wednesday to Friday: by the following Wednesday. Paydays Saturday to Tuesday: by the following Friday |
| $100,000 next-day rule | Anyone who accumulates $100,000 or more in taxes on any day | By the next business day |
| Under $2,500 per quarter | Small liabilities, under specific conditions | Can be paid with the return instead of deposited |
FUTA deposits work separately. If your FUTA liability is more than $500 for a quarter, deposit it by the end of the following month. If it’s $500 or less, carry it forward to the next quarter.
Payroll forms and filing deadlines
- Form 941, quarterly: Reports wages, withheld income tax and Social Security and Medicare. Due by the last day of the month after each quarter ends: April 30, July 31, October 31 and January 31. If you deposited all taxes on time, you get until the 10th of the second month.
- Form 944, annual: Only for very small employers that the IRS has notified in writing they can file annually instead of quarterly, generally those expecting $1,000 or less in annual employment taxes.
- Form 940, annual: Reports FUTA tax. Due January 31, with extra time if all FUTA was deposited on time.
- Forms W-2 and W-3: Give each employee a W-2 and file copies with the Social Security Administration by January 31.
- State filings: Quarterly unemployment wage reports and state withholding returns, on state schedules.
New for 2026 W-2s: Under the 2025 tax law that created deductions for qualified tips and overtime, the IRS requires employers to report qualified overtime compensation in box 12 with code TT and qualified tips with code TP on 2026 Forms W-2. If you pay overtime or employ tipped workers, confirm your payroll system supports these codes.
How to run payroll, step by step
- Collect hours for hourly staff and confirm any changes, such as new hires, raises or time off.
- Calculate gross pay, including overtime, bonuses and tips.
- Apply pre-tax deductions for eligible benefits.
- Calculate withholding for federal, state and local income tax, Social Security and Medicare.
- Apply post-tax deductions and garnishments.
- Pay employees by direct deposit or check, with a pay stub showing earnings and deductions. Some states require specific pay stub details.
- Record the payroll in your accounting software, including your employer taxes.
- Deposit taxes on your federal and state schedules.
- File returns quarterly and annually.
- Keep records. The IRS says to keep employment tax records for at least 4 years.
What payroll software automates
Most small businesses use payroll software rather than doing it by hand. Common features include:
| Task | Manual payroll | Typical payroll software |
|---|---|---|
| Withholding calculations | You use IRS and state tables | Calculated automatically and updated for rate changes |
| Direct deposit | Set up through your bank | Built in |
| Federal and state tax deposits | You schedule each one | Often made automatically |
| Forms 941, 940, W-2 and state returns | You prepare and file | Often prepared and filed for you |
| New hire reporting | You submit to the state | Often included |
| Time tracking and PTO | Separate tools | Often integrated or available as an add-on |
| Accounting sync | Manual entries | Syncs with accounting software |
Payroll tools are sold under a few pricing models: a monthly base fee plus a per-employee fee, tiered plans that add HR features and benefits administration, or full-service options where the provider takes responsibility for filings. A professional employer organization (PEO) goes further by co-employing your staff to handle benefits and HR. Prices vary, so compare total cost for your headcount and check which filings are included. Our guide on choosing small business accounting software covers how payroll fits with your books.
Common payroll mistakes to avoid
- Misclassifying workers as contractors
- Missing deposit deadlines, which triggers penalties that grow with the delay
- Using outdated W-4 information or not collecting a new W-4 when an employee asks to change withholding
- Forgetting state and local taxes, especially for remote employees in other states
- Not paying overtime to non-exempt employees, including salaried ones who don’t meet exemption tests
- Falling for payroll diversion scams, where a fake email asks to change an employee’s direct deposit account. Verify any change by phone using a number you already have. Our guide to business email compromise explains how these scams work.
- Weak security on payroll accounts. Turn on two-factor authentication for payroll and banking logins.
The bottom line
Running payroll comes down to calculating pay correctly, withholding the right taxes, depositing them on time and filing the right forms. Learn your deposit schedule, keep withheld taxes separate from operating cash and let payroll software handle the calculations and filings. Then review each payroll run before it goes out, because fixing a mistake after payday takes much longer than catching it before.
Sources
- IRS Publication 15 (2026), Employer’s Tax Guide — 2026 Social Security and Medicare rates, wage base, FUTA, deposit schedules and filing deadlines
- IRS: Hiring employees — employer tax responsibilities and Form W-4
- IRS: General Instructions for Forms W-2 and W-3 (2026) — W-2 filing, including new codes for qualified overtime and tips
- IRS Publication 15-T (2026), Federal Income Tax Withholding Methods — withholding tables
Frequently asked questions
How do I run payroll for the first time?
Get an EIN and state payroll tax accounts, collect a Form W-4 from each employee, choose a pay schedule and set up payroll software or a provider. For each pay period, calculate gross pay, subtract taxes and deductions, pay employees, then deposit withheld and employer taxes on schedule. Most new employers start as monthly depositors. This is not tax advice.
How much does an employer pay in payroll taxes?
At the federal level, employers pay 6.2% Social Security tax on wages up to $184,500 in 2026 and 1.45% Medicare tax with no limit, matching what employees pay. Employers also pay federal unemployment tax, usually 0.6% on the first $7,000 per employee after the state credit, plus state unemployment tax at a rate your state assigns.
When are payroll taxes due?
It depends on your deposit schedule. Monthly depositors deposit by the 15th of the following month. Semiweekly depositors deposit by the next Wednesday or Friday depending on payday. Anyone who builds up $100,000 or more in taxes on a single day must deposit by the next business day. Form 941 is due the last day of the month after each quarter ends.
Can I do payroll myself without software?
Yes, but it takes time and care. You would calculate withholding with IRS Publication 15-T and state tables, make electronic tax deposits through EFTPS or another IRS option, file Forms 941, 940 and W-2 yourself and handle state filings. Many small businesses find payroll software worth the cost because it updates rates and reduces deadline mistakes.
What is the difference between Form 941 and Form 940?
Form 941 is filed quarterly and reports wages paid, federal income tax withheld and Social Security and Medicare taxes. Form 940 is filed once a year and reports federal unemployment (FUTA) tax, which only the employer pays. Very small employers may be allowed by the IRS to file Form 944 annually instead of Form 941.
What happens if I miss a payroll tax deposit?
The IRS charges failure-to-deposit penalties that increase the longer a deposit is late, plus interest. Repeated or serious failures can lead to the Trust Fund Recovery Penalty, which can make owners and other responsible people personally liable for unpaid withheld taxes. If you miss a deposit, make it as soon as possible and talk to your accountant.
What does payroll software cost?
Pricing usually combines a monthly base fee with a per-employee fee, with higher tiers adding HR tools, benefits administration or filing guarantees. Full-service providers and PEOs cost more but take on more work. Prices vary by provider and headcount, so compare the total monthly cost for your team and confirm that federal and state filings are included.
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