Hiring your first employee is exciting, but payroll comes with serious legal obligations. Get it wrong and you face penalties, interest, and unhappy employees. Here is how to do it right.
Understanding Payroll Taxes: FICA, FUTA, and SUTA
As an employer, you are responsible for withholding and paying several types of payroll taxes. FICA (Federal Insurance Contributions Act) covers Social Security and Medicare. The Social Security tax rate is 6.2% each for employer and employee on wages up to the annual limit ($168,600 in 2024). The Medicare tax rate is 1.45% each with no wage cap. You withhold the employee's share from their paycheck and pay the employer's share out of your own pocket. That means the total FICA cost on a $50,000 salary is roughly $7,650 -- half from the employee and half from you.
FUTA (Federal Unemployment Tax Act) is paid entirely by the employer at a rate of 6.0% on the first $7,000 of each employee's wages. However, you receive a credit of up to 5.4% if you pay your state unemployment taxes on time, bringing the effective FUTA rate down to 0.6%. SUTA (State Unemployment Tax Act) rates vary by state and by your experience rating, which is based on how many former employees have filed unemployment claims. New employers typically pay a default rate that decreases over time if you maintain a stable workforce.
Setting Up Payroll: W-4s, I-9s, and State Forms
Before you can pay an employee, they need to complete several forms. The W-4 (Employee's Withholding Certificate) tells you how much federal income tax to withhold from their paycheck based on their filing status and claimed adjustments. Most states have their own withholding form as well. The I-9 (Employment Eligibility Verification) confirms the employee is legally authorized to work in the United States. You must complete the I-9 within three days of the employee's start date.
You also need to register for a state employer account to withhold and remit state income taxes and unemployment insurance. Most states require you to report new hires to a state directory within 20 days of their start date. If you operate in multiple states, you need to register and withhold taxes in each state where employees work. Keep all payroll records for at least four years as required by the IRS, and even longer if your state requires it.
Pay Frequency and Payment Methods
Most small businesses pay employees either biweekly (every two weeks, resulting in 26 pay periods per year) or semi-monthly (twice per month on set dates, resulting in 24 pay periods). Some states have minimum pay frequency requirements -- for example, some require at least semi-monthly payment. Check your state's labor laws before choosing a schedule.
Direct deposit is the standard payment method and most payroll providers set it up automatically. Some states require you to offer direct deposit, and most employees expect it. You can also pay with paper checks or payroll debit cards, though these add administrative work. Each pay period, you must provide a pay stub showing gross wages, all withholdings and deductions, and net pay. Most states require detailed pay stubs either in print or electronic format.
Choosing a Payroll Provider
Running payroll manually is theoretically possible but rarely worth the risk for most small businesses. A mistake in tax calculations or a late deposit can trigger IRS penalties that far exceed the cost of a payroll service. Popular options for small businesses include Gusto (starting around $40 per month plus $6 per employee), QuickBooks Payroll ($45+ per month plus $6 per employee), and ADP and Paychex for businesses that want more hands-off service with dedicated support.
A good payroll provider handles tax calculations, withholding, direct deposits, tax filings (quarterly 941s and annual W-2s), new hire reporting, and generates the reports your accountant needs. Many also handle benefits administration, time tracking, and workers' compensation insurance. When comparing providers, look at the total cost including per-employee fees, the quality of customer support, how well it integrates with your accounting software, and whether it handles multi-state payroll if you need it.
Common Payroll Mistakes to Avoid
The most expensive payroll mistake is misclassifying employees as independent contractors. If the IRS reclassifies your contractors as employees, you owe back payroll taxes, penalties, and interest going back years. The general rule is that if you control how, when, and where someone works, they are an employee regardless of what your contract says.
Other common mistakes include making late tax deposits (the IRS assesses penalties of 2-15% depending on how late), failing to track overtime properly (non-exempt employees must receive 1.5x pay after 40 hours per week under federal law), using payroll tax withholdings to cover business expenses instead of depositing them on time, and not keeping adequate records. Payroll tax obligations are among the few business debts that can pierce your LLC liability protection and hold you personally responsible, so treat them with the seriousness they deserve.