How much should you pay employees? 6 steps to set pay

Published Wednesday 6 May 2026

Table of contents

• How to determine what to pay your employees in 6 steps
• Types of employee compensation
• Pay equity and transparency
• Simplify payroll and employee payments with Xero
• FAQs on paying employees

Key takeaways

• Research salary data from multiple sources, including the Bureau of Labor Statistics (BLS), PayScale, and Glassdoor, to set competitive pay that attracts the right candidates
• Factor in the full cost of employment, not just salary. Employer taxes, benefits, and insurance typically add 25%–40% on top of base pay
• Stay compliant with federal and state wage laws, including minimum wage requirements, overtime rules, and pay frequency regulations
• Build a total compensation package that balances salary with perks like flexibility, bonuses, and professional development to stand out in a competitive market

How to determine what to pay your employees in 6 steps

Setting employee pay is a balancing act between what candidates expect, what the market pays, and what your business can afford. These 6 steps walk you through researching, calculating, and building a compensation offer that works for everyone. You might also consider whether you can cover the role with part-time or contract support before committing to a full-time hire.

1. Write an accurate job description

A clear, detailed job description is the foundation for setting the right salary. It helps you compare the role to similar positions in your industry and gives candidates a transparent view of what you're looking for.

Start with the job title. Make sure it reflects the nature of the work and is generic enough to compare against similar roles in your market. Then list the core duties, responsibilities, and the percentage of time you expect the employee to spend on each task.

Once you've defined the skills, qualifications, and reporting relationships, you'll have what you need to start gathering salary data. The BLS Occupational Outlook Handbook is a helpful resource for understanding role requirements and typical qualifications. You can also get started with a free job description template to save time.

2. Research current salary data

Up-to-date salary data helps you set pay that's competitive without overspending. Compensation benchmarks shift as demand for certain skills grows, so it's worth gathering fresh data every time you hire.

Start with online tools to get a market snapshot for your location and industry:

• PayScale for free salary reports by job title, location, and experience
• BLS Occupational Employment and Wage Statistics for government-backed wage data
• Glassdoor and LinkedIn Salary Insights for employee-reported compensation
• Industry-specific salary surveys from trade associations

Online research gives you a solid starting point, but talking to people adds valuable context. Reach out to other business owners, recruitment firms, suppliers, and customers who've hired for similar roles. If you're hiring a senior designer, for example, chat with senior designers in your network to understand their expectations.

3. Understand legal requirements

Federal and state wage laws set the floor for what you can pay, and getting it wrong can lead to costly penalties. Before you make any offer, make sure you understand your legal obligations.

The Fair Labor Standards Act (FLSA) sets the federal minimum wage at $7.25 per hour, but many states and cities require higher minimums. You'll need to check the laws in your specific location, as the higher rate always applies. The FLSA also governs overtime rules, requiring time-and-a-half pay for non-exempt employees who work more than 40 hours per week.

Pay equity laws are expanding across the US too. Several states now prohibit asking about salary history and require pay transparency in job postings. Staying ahead of these requirements protects your business and builds trust with candidates.

Use this checklist to make sure you're covered:

• check minimum wage compliance at federal, state, and local levels
• confirm payment frequency and method requirements for your state
• classify each role as exempt or non-exempt for overtime purposes
• maintain records of hours worked and wages paid
• review vacation pay and paid leave rules in your jurisdiction

Check out the IRS guide to understanding employment taxes for more details on your tax obligations as an employer. You can also read more about payroll compliance to make sure your first hire is set up correctly.

4. Find out a candidate's pay expectations

Your candidates likely have a number in mind, and understanding their expectations early saves time for both sides. Use the interview process to get a sense of what they're looking for and whether it aligns with your budget.

Ask about:

• current pay: are they on a fixed salary, commission, or hourly wages?
• additional benefits: do they receive insurance, extra vacation days, remote work options, or flexible hours?
• reasons for applying: are they seeking a more senior role, higher pay, a partnership opportunity, or a values-driven workplace?

These conversations give you valuable insight into what the candidate values most. Some candidates prioritize salary above all else, while others place a high value on flexibility or career development. That information helps you shape a more appealing offer.

5. Calculate the true cost of an employee

The salary you offer is only part of what an employee actually costs your business. Employer taxes, benefits, and insurance add significantly to the total, so it's important to calculate the full picture before committing to a number.

If you're new to running payroll, the small business payroll guide covers the basics of deductions and reporting. Here are the key employer costs beyond salary:

• Federal Insurance Contributions Act (FICA) taxes: 7.65% of wages, broken down into 6.2% for Social Security and 1.45% for Medicare
• Federal Unemployment Tax Act (FUTA): 6% on the first $7,000 of each employee's wages, though credits for state unemployment taxes typically reduce the effective rate to 0.6%
• State Unemployment Tax Act (SUTA): rates vary by state and your claims history
• Workers' compensation insurance: required in most states, with rates based on industry risk
• Benefits: health insurance, retirement contributions, paid time off, and other perks

As a general rule, total employment costs run 1.25–1.4 times the base salary. So an employee earning $60,000 per year could cost your business $75,000–$84,000 in total.

Think about the return on your investment too. How much revenue will this employee help generate? How much time will they free up for you to focus on growing the business?

Consider how the role fits into your organization's pay structure, because a new hire's compensation can affect existing employees' expectations. When it's time for a raise in a year or two, make sure your budget can handle that too.

6. Build a competitive offer

A competitive offer goes beyond the base salary. Candidates evaluate the full package, so think about what combination of pay and perks will attract the right person for your business.

You have several options to consider:

• Straight salary: the simplest approach, but it can limit your appeal if competitors offer more comprehensive packages
• Salary plus bonuses: tying part of compensation to performance targets motivates goal-oriented candidates and can be more affordable upfront
• Stock or equity: sharing ownership can attract top talent, especially for startups or growing businesses with limited cash flow
• Flexible work arrangements: up to a third of employees say they'd choose certain perks over a pay raise, so remote work options, extra vacation days, or flexible hours carry real value

Whatever you offer, make sure it's competitive. Staff turnover tends to increase when employees feel underpaid, and the cost of hiring and training a replacement often exceeds the cost of offering a fair package from the start. Check out the hiring employees guide for more tips on bringing the right people onto your team.

Types of employee compensation

Choosing the right pay structure depends on the role, your industry, and your business model. The four most common compensation types each come with different advantages for both you and your employees.

• Salary: a fixed annual amount paid in regular installments, regardless of hours worked. Best for roles with predictable workloads and responsibilities that are hard to measure by the hour.
• Hourly wages: pay based on actual hours worked, with overtime for non-exempt employees who exceed 40 hours per week. Ideal for roles with variable schedules or seasonal demand.
• Commission: compensation tied directly to sales performance or revenue generated. Common in sales roles, it can be structured as commission-only or as a base salary plus commission.
• Hybrid structures: a combination of salary, hourly, commission, and bonuses tailored to the role. Many businesses use a base salary with performance bonuses or profit-sharing to balance stability with incentive.

If you're a business owner figuring out your own pay, these same steps apply. Start by researching what similar roles pay in your market, calculate what the business can afford after covering operating costs and taxes, and set a compensation plan that balances your personal financial needs with the company's growth goals.

Pay equity and transparency

Fair pay practices aren't just a legal requirement. They're becoming a competitive advantage as candidates increasingly expect transparency around compensation. Setting clear, consistent pay standards helps you attract talent and retain your team.

Pay transparency is gaining momentum across the US. According to the PayScale 2026 Compensation Best Practices Report, 49% of organizations are targeting public pay transparency. Several states now require salary ranges in job postings, and more legislation is on the way. Getting ahead of these trends positions your business as a trustworthy employer.

One practical tool for monitoring pay fairness is the compa-ratio, which compares an employee's actual pay to the midpoint of the pay range for their role. A compa-ratio of 1.0 means an employee earns exactly at the midpoint. Ratios below 1.0 may signal underpayment, while ratios above 1.0 could indicate someone is above the range. Reviewing compa-ratios regularly helps you spot and address pay gaps before they become larger issues.

To build a fair pay structure, start by defining salary ranges for each role based on your market research. Document the criteria you use to set pay, including experience, skills, location, and performance. Review compensation across your team at least once a year to identify and correct any gaps tied to gender, race, or other factors unrelated to the job itself.

Simplify payroll and employee payments with Xero

Once you've figured out what to pay your team, you need a reliable way to process payroll and stay on top of tax obligations. Xero Payroll, powered by Gusto, handles pay runs, tax calculations, and filings so you can spend less time on admin and more time running your business. Get one month free to see how it works.

FAQs on paying employees

Here are answers to common questions small business owners ask about setting and managing employee pay.

How much does it really cost to employ someone beyond their salary?

Total employment costs typically run 1.25–1.4 times the base salary once you add employer taxes, insurance, and benefits. For an employee earning $50,000, expect to pay $62,500–$70,000 in total.

Should I pay employees a salary or an hourly wage?

Salaried positions work best for roles with consistent responsibilities and predictable hours, while hourly pay suits variable schedules or overtime-eligible work. Check FLSA classification requirements, as non-exempt employees must receive overtime pay for hours exceeding 40 per week.

How often should I review employee pay?

Review compensation at least once a year, ideally during your annual budgeting process. Check current market rates for each role, evaluate individual performance, and compare your pay ranges against industry benchmarks. Regular reviews help you retain top performers and stay competitive without waiting for employees to ask for a raise.

What is a compa-ratio and how do I use it?

A compa-ratio measures how an employee's pay compares to the midpoint of the salary range for their role. Calculate it by dividing the employee's actual salary by the range midpoint. A ratio of 1.0 means they're paid at the midpoint, below 1.0 suggests they may be underpaid, and above 1.0 means they're earning above the range. It's a simple way to monitor pay equity across your team.

How do I stay compliant with wage and hour laws?

Start by understanding federal requirements under the FLSA, including minimum wage ($7.25 per hour federally, though many states set higher rates), overtime rules, and employee classification standards. Check your state's specific requirements for pay frequency, record-keeping, and paid leave. Consult the Department of Labor's website or work with a qualified advisor to make sure your practices meet current regulations.