A payroll is the total amount a business pays its employees during a given pay period, along with the entire system of calculating wages, withholding taxes, and distributing paychecks. If you run a business with even one employee, you have a payroll. The term covers both the money itself and the process of getting it right.
How Payroll Works Step by Step
Every payroll cycle follows the same basic sequence, whether a company pays weekly, biweekly, or monthly. First, employees record the hours they worked (salaried employees have a fixed amount, so this step is simpler for them). Next, the employer calculates gross pay, which is the total earned before anything is subtracted. Then taxes and other deductions are withheld. Finally, the remaining amount, called net pay, is delivered to the employee through direct deposit, a paper check, or a pay card.
That gap between gross pay and net pay is where most of the complexity lives. A worker earning $5,000 in gross pay during a pay period might take home $3,700 after federal income tax, Social Security, Medicare, state taxes, health insurance premiums, and retirement contributions are all subtracted.
What Gets Deducted From Each Paycheck
Payroll deductions fall into two categories: mandatory withholdings required by law and voluntary deductions the employee has chosen.
Mandatory withholdings include federal income tax (based on the information the employee provides on Form W-4), Social Security tax at 6.2% of wages, and Medicare tax at 1.45% of wages. Most employees also owe state and, in some areas, local income tax. If a court has ordered wage garnishments for child support or debt, those come out automatically too.
Voluntary deductions are things the employee has opted into. Common examples are health insurance premiums, contributions to a 401(k) or similar retirement plan, life insurance, and flexible spending accounts. Many of these are pre-tax, meaning they reduce the employee’s taxable income, which lowers the amount owed in income tax.
Taxes the Employer Pays
Employees are not the only ones paying payroll taxes. The employer matches the employee’s Social Security and Medicare contributions dollar for dollar: another 6.2% for Social Security and 1.45% for Medicare on every paycheck. Social Security tax applies only up to a wage base limit, which is $184,500 for 2026. Medicare has no cap, so it applies to every dollar of wages regardless of how much the employee earns.
Employers also pay federal unemployment tax (FUTA) at a rate of 6.0% on the first $7,000 of each employee’s annual wages. In practice, most employers receive a credit of up to 5.4% for contributions to their state unemployment fund, bringing the effective FUTA rate down to 0.6%. On top of that, every state charges its own unemployment insurance tax, with rates that vary based on the employer’s industry and claims history.
For a small business, these employer-side taxes add roughly 8% to 10% on top of every dollar paid in wages. That means an employee who earns $50,000 costs the company closer to $54,000 or $55,000 before you factor in benefits.
Forms and Filing Requirements
Running payroll creates several federal reporting obligations throughout the year.
- Form W-4: Each employee fills this out when hired. It tells the employer how much federal income tax to withhold based on the employee’s filing status and other adjustments.
- Form 941: Employers file this quarterly to report all federal income tax withheld, plus both the employee and employer shares of Social Security and Medicare taxes.
- Form 940: Filed annually to report federal unemployment tax. If the FUTA tax owed exceeds $500 in any quarter, the employer must deposit it by the end of the following month.
- Form W-2: At the end of the year, employers must prepare a W-2 for each employee showing total wages and taxes withheld. Copies go to the employee, the Social Security Administration, and applicable state tax agencies. The deadline is January 31.
Most states have their own parallel filings for income tax withholding and unemployment insurance. Missing a deadline can trigger penalties that accumulate quickly, so keeping a calendar of due dates is one of the most important parts of payroll management.
Pay Schedules
Businesses choose how often to run payroll, and the most common schedules are weekly, biweekly (every two weeks), semimonthly (twice a month, usually the 1st and 15th), and monthly. Biweekly is the most popular, producing 26 pay periods per year. The choice affects cash flow for the business and budgeting for employees. Many states regulate the minimum frequency, so employers cannot simply choose to pay once a year.
Ways to Manage Payroll
Small businesses generally handle payroll in one of three ways.
Manual Processing
This means calculating everything by hand or in a spreadsheet, writing checks, and filing tax forms yourself. It costs nothing beyond your time, but it is extremely error-prone and only practical for a business with one or two employees. A single miscalculation on tax withholding can lead to penalties from the IRS.
Payroll Software
Cloud-based payroll platforms automate the math, generate pay stubs, handle direct deposits, calculate tax withholdings, and file quarterly and annual forms on your behalf. Most charge a base monthly fee plus a per-employee fee. For a business with five to ten employees, expect to pay roughly $40 to $100 per month depending on the provider and features included. This is the sweet spot for most small businesses: affordable enough to justify and reliable enough to avoid mistakes.
Outsourced Payroll Services
A payroll provider or accountant handles the entire process for you. Pricing models vary: some charge a flat monthly fee, others price by payroll volume or number of transactions, and many add charges for extras like year-end tax filings or compliance audits. Outsourcing makes the most sense for businesses that are growing quickly, operating in multiple states, or dealing with complex pay structures like commissions and bonuses.
Why Accuracy Matters
Payroll errors create problems in two directions. Underpaying employees can violate wage and hour laws and erode trust. Underreporting or late-depositing taxes triggers IRS penalties that start at 2% of the unpaid amount and escalate to 15% for deposits more than 10 days late. The IRS assesses these penalties automatically, so they can pile up before you realize there is a problem.
Getting payroll right also matters for your employees’ financial lives. The numbers on their pay stubs affect their ability to qualify for mortgages, car loans, and rental applications. And the W-2 you issue at year-end is the foundation of their tax return. Inaccurate reporting can trigger IRS notices for your employees, not just for you.