Small Business Payroll Guide

Payroll Is More Than Writing Checks

For small business owners hiring their first employee — or deciding whether to hire at all — payroll is one of the most misunderstood parts of running a business. The listed salary is just the starting point. By the time you factor in employer taxes, mandatory insurance, paid leave, and overhead, the actual cost of an employee is typically 20–40% higher than the number on the offer letter.

This guide breaks down every component of payroll — what you withhold from employees, what you pay on top as the employer, when overtime kicks in, how to think about contractors vs. employees, and what tools can help you run the numbers before you make a hiring decision.

Payroll Taxes: Who Pays What

Payroll taxes involve both the employee and the employer. Some are withheld from the employee's paycheck; others are paid entirely by the employer on top of wages. Understanding which is which is essential for budgeting accurately.

What this means for your budget

For every dollar of gross wages you pay an employee, you owe roughly an additional 8–12 cents in employer-side taxes (Social Security + Medicare + FUTA + SUTA). This is before any benefits. On a $60,000 salary, that's $4,800–$7,200 per year in employer taxes alone — money that has to come from your operating budget, not the employee's paycheck.

From Gross Pay to Net Pay: What Gets Withheld

Employees often feel surprised by how much smaller their paycheck is than their salary would suggest. The gap between gross pay (the salary) and net pay (the take-home) is typically 20–35% for most workers, depending on their tax situation and benefit elections.

Here's what comes out of a typical paycheck:

• Federal income tax — withheld based on the employee's W-4 and IRS withholding tables. This varies significantly based on filing status, allowances, and any additional withholding the employee requests.
• Social Security (employee share) — 6.2% on wages up to $176,100 (2025)
• Medicare (employee share) — 1.45% on all wages (plus 0.9% on wages over $200,000)
• State income tax — varies by state; nine states have no income tax
• Pre-tax deductions — 401(k) contributions, health insurance premiums, HSA contributions, and similar deductions reduce taxable income before taxes are calculated

Overtime: When It Applies and What It Costs

Under the federal Fair Labor Standards Act (FLSA), non-exempt employees must be paid at least 1.5 times their regular rate for all hours worked over 40 in a workweek. Some states have stricter rules — California, for example, requires overtime after 8 hours in a single day, and double time after 12 hours in a day or on the seventh consecutive day of work.

Who is exempt from overtime?

Exemptions are more limited than many employers assume. To be overtime-exempt, an employee generally must meet all three criteria:

• Earn at least $684/week ($35,568/year) on a salary or fee basis
• Be paid a fixed salary that doesn't vary based on hours worked
• Primarily perform executive, administrative, or professional duties as defined by the FLSA

Job title alone does not create an exemption. An employee with the title "manager" who earns $30,000/year is not overtime-exempt. Misclassifying employees as exempt is one of the most common wage-and-hour violations small businesses face.

The real cost of overtime

Overtime isn't just a payroll line item — it affects your employer tax obligations too. Since overtime wages are regular wages, you owe Social Security, Medicare, FUTA, and SUTA on them just like any other pay. An hour of overtime for a $25/hour employee costs you $37.50 in wages plus approximately $2.87 in employer taxes — $40.37 total per overtime hour.

Contractor vs. Employee: The Classification Question

One of the biggest decisions a small business faces when bringing on help is whether to hire an employee or engage an independent contractor. The financial difference is significant — and so are the legal risks of getting it wrong.

The financial case for contractors

On paper, contractors look cheaper: no employer FICA taxes, no unemployment insurance, no benefits, no overtime liability. For short-term or project-based work, contractors often make financial sense. But for ongoing, integral roles, the calculus is different — and misclassifying a worker as a contractor when they function as an employee exposes you to back taxes, penalties, and potential lawsuits.

The IRS classification test

The IRS evaluates three categories of factors when determining worker classification:

• Behavioral control — Do you control what the worker does and how they do it? Do you set their hours, provide training, dictate their process?
• Financial control — Do you control the business aspects of the worker's job? Do they invest in their own tools and equipment? Do they work for multiple clients?
• Type of relationship — Is there a written contract? Do you provide benefits? Is the relationship indefinite or project-based?

The more control you exert over how someone works, the more likely they are to be an employee under the IRS definition — regardless of what your contract says.

Running the numbers before you decide

Before deciding between a contractor and an employee, it's worth modeling the full cost of each option side by side — including all employer taxes, benefits, equipment, and overhead. The difference between a $60,000 salary and what it actually costs to employ that person is often $15,000–$25,000 per year.

Payroll Schedules and Deposit Requirements

Once you have employees, you need to establish a consistent pay schedule and understand your tax deposit obligations to the IRS. Getting this wrong results in penalties — and the IRS does not waive them lightly.

Common pay schedules

• Weekly — 52 payrolls per year. Common in construction and hourly-wage industries. More administrative work but employees appreciate the frequency.
• Bi-weekly — 26 payrolls per year. The most common schedule in the US. Easy to plan around and reduces administrative burden versus weekly.
• Semi-monthly — 24 payrolls per year, typically on the 1st and 15th. Common for salaried staff. Slightly harder to calculate for hourly employees.
• Monthly — 12 payrolls per year. Less common; can cause cash flow stress for employees and some states restrict it for hourly workers.

Federal tax deposit schedule

The IRS assigns you a deposit schedule — either monthly or semi-weekly — based on your total payroll tax liability from the prior lookback period. New employers are generally monthly depositors. As your payroll grows, you may move to semi-weekly. The key rule: taxes withheld from employee paychecks must be deposited on schedule, not just paid with your quarterly 941 return.

The True Cost of Hiring: A Complete Picture

When a small business owner asks "can I afford to hire someone at $50,000?", the answer depends on whether they're thinking about the salary or the total cost. Here's what the full picture typically looks like:

This is why experienced business owners talk about the "1.25x to 1.4x rule" — multiply the salary by 1.25 to 1.4 to get closer to the real cost. The exact multiplier depends on your benefits package, state, and industry, but the principle holds: the cost of an employee is always higher than their salary.

For roles where the work is project-based or the volume is uncertain, a contractor may offer more financial flexibility — you pay only when there's work to do, with no ongoing overhead. Use the calculator below to model both scenarios with your specific numbers before making the call.

Frequently Asked Questions