What is payroll?

Published Monday 15 June 2026

Table of contents

• What is payroll?
• Understanding payroll components
• Payroll frequency: how often to pay employees
• Five employer payroll responsibilities
• How to set up payroll
• How to run payroll
• Payroll tax obligations
• Your payroll record-keeping obligation
• Payroll regulations to know
• How to manage payroll
• How much does payroll cost?
• What are employee payroll responsibilities?
• Simplify payroll with Xero
• FAQs on payroll

Key takeaways

• Payroll is the process of calculating employee wages, withholding taxes, paying employer contributions, and filing required forms with federal and state agencies.
• You're responsible for setting up payroll before an employee's first day, running it on every payday, and meeting tax filing deadlines throughout the year.
• Payroll costs go beyond wages: expect to pay an additional 15% to 20% on top of each employee's salary for taxes, benefits, and employer contributions.
• Payroll software automates calculations, tax filings, and recordkeeping, helping you stay compliant and save time on administrative tasks.

What is payroll?

Payroll is the process of compensating employees for their work, including calculating wages, withholding taxes, paying employer contributions, and maintaining records for compliance. For small business owners, payroll covers everything from tracking hours and pay rates to submitting required forms to the Internal Revenue Service (IRS) and state tax agencies.

Getting payroll right matters. Errors can lead to IRS penalties, unhappy employees, and compliance problems. The good news is that once you understand the basics, payroll becomes a manageable, repeatable process you can run with confidence.

Understanding payroll components

Every payroll calculation involves the same building blocks. Understanding these components helps you see how employee pay comes together and where your obligations sit.

Gross wages

Gross wages are the total amount you owe an employee before any deductions. For hourly workers, multiply hours worked by their hourly rate, including any overtime. For salaried employees, divide their annual salary by the number of pay periods in the year.

Deductions and withholdings

Deductions reduce an employee's gross pay before they receive their paycheck. Common deductions include:

• Federal income tax: based on the employee's Form W-4 selections
• State and local income tax: varies by location
• Social Security and Medicare (Federal Insurance Contributions Act, or FICA): a combined 7.65% deduction from the employee's wages, split into 6.2% for Social Security on wages up to $184,500 for 2026, and 1.45% for Medicare on all wages
• Benefits contributions: health insurance, retirement plans, and other voluntary deductions

Employer contributions

Employer contributions are amounts you pay on top of employee wages. These don't come from the employee's paycheck. They include:

• Employer FICA match: 7.65% of each employee's wages (up to the Social Security wage base)
• Federal Unemployment Tax Act (FUTA): 6% on the first $7,000 of wages per employee; however, employers can receive a credit of up to 5.4% for paying state unemployment taxes, lowering the effective rate to 0.6%. Employers in credit reduction states (California and the U.S. Virgin Islands for 2026) may pay a higher effective rate.
• State unemployment tax (SUTA): varies by state

Payroll taxes

Payroll taxes include both the amounts you withhold from employees and the taxes you owe as an employer. Together, these fund Social Security, Medicare, and unemployment insurance programs. Learn more in the guide on payroll taxes.

Net pay

Net pay is the amount employees actually receive after all deductions. This is the "take-home pay" that appears on their paycheck or direct deposit statement.

Payroll frequency: how often to pay employees

Your payroll frequency determines how often you pay employees. The right schedule depends on your cash flow, industry norms, and state requirements, since some states mandate a minimum pay frequency.

The 4 most common payroll schedules are:

• Weekly (52 pay periods per year): common in construction, retail, and hospitality; gives employees frequent paychecks but increases your administrative workload
• Biweekly (26 pay periods per year): the most popular option for small businesses; balances employee satisfaction with manageable processing effort
• Semimonthly (24 pay periods per year): employees are paid on 2 set dates each month (for example, the 1st and 15th); simplifies budgeting but can complicate overtime calculations for hourly workers
• Monthly (12 pay periods per year): lowest administrative burden, but employees wait longer between paychecks; less common and not permitted in all states

Check your state's labor department website for minimum pay frequency requirements before choosing a schedule.

Five employer payroll responsibilities

Payroll involves more than issuing paychecks. Here are the 5 core responsibilities you'll manage as an employer:

• Pay wages: compensate employees for hours worked or salary earned
• Calculate benefits: track vacation, sick leave, insurance, and retirement contributions
• Withhold taxes: deduct federal and state income taxes from employee pay
• Pay employer taxes: submit payroll taxes you owe as an employer
• File reports: submit required forms to prove compliance with tax agencies

These responsibilities fall into 3 phases. At hiring, you set up each new employee in your payroll system. On payday, you calculate pay, make deductions, and issue payments. For tax agencies, you file required forms and submit tax payments on schedule.

How to set up payroll

Setting up payroll happens before your employee's first day and makes sure you can pay them correctly from the start. Complete these steps to stay compliant and avoid penalties.

1. Learn wage and salary rules

Understand overtime requirements before classifying employees. Paying a salary doesn't automatically exempt you from overtime rules. Check with the Department of Labor for current salary thresholds and exemption criteria.

2. Collect Form I-9

Have employees complete the current edition of Form I-9 (edition date 08/01/23, valid through 05/31/2027) with supporting documents to verify they can legally work in the US. Employers enrolled in E-Verify may use the alternative remote document examination procedure instead of reviewing physical documents in person.

3. Submit new hire reporting

Send the required form to the state where you're reporting the employee's wages and taxes. Most states require you to report new hires within 20 days of their start date. Check your state's hiring employees requirements for specific deadlines.

4. Collect Form W-4

Use this federal form to calculate how much income tax to withhold from each employee's paycheck. Check with your state tax office for any state-specific version. If you're hiring in a new state, register with that state's tax agency first.

How to run payroll

Running payroll on payday involves 4 main steps. Following them consistently keeps your employees paid accurately and your records in order.

1. Calculate gross pay

Determine what you owe each employee for the pay period based on hours worked or salary. Include any overtime, bonuses, or commissions that apply.

2. Make deductions

Subtract taxes, benefits contributions (insurance, retirement), and any other withholdings from gross pay. Use each employee's W-4 and benefits elections to determine the correct amounts.

3. Add employer contributions

Calculate the payroll taxes you owe as an employer. Not all payroll taxes come from employee pay. Your FICA match, FUTA, and SUTA contributions are separate costs. Learn more in the guide on payroll taxes.

4. Issue payment and records

Pay your employee via direct deposit, check, or another approved method. Update vacation and sick day balances, and provide a pay stub summarizing all calculations.

Payroll tax obligations

Payroll tax obligations require you to report and pay taxes to federal and state governments on a set schedule. You're responsible for 2 main tasks:

• File tax forms: submit Form 941 (quarterly) and W-2s (annually) to the IRS. Since 2024, employers filing 10 or more information returns (including W-2s) in a calendar year must e-file those returns. Check with your state tax agency for additional requirements.
• Pay taxes: remit the taxes you withheld from employee pay, plus the payroll taxes you owe as an employer.

Tax agencies set specific deadlines for these tasks. Payments may be due weekly, quarterly, or annually depending on your tax liability.

Keep withheld taxes separate from operating funds. Many businesses use a dedicated bank account to hold tax money until payment is due.

Your payroll record-keeping obligation

You're required to retain payroll documents for a specific period. Per IRS guidelines, you must keep all records of employment taxes for at least 4 years after filing the 4th quarter for the year. The IRS may ask you to provide:

• Employee personal information
• Copies of filed tax forms
• Dates and amounts of tax payments
• Dates and amounts of wage payments
• Expense reimbursements
• Retirement payment records

For more details, visit the IRS employer's tax guide (Publication 15).

Payroll regulations to know

Several federal laws govern how you pay employees and handle payroll taxes. Understanding these regulations helps you stay compliant and avoid costly penalties.

Fair Labor Standards Act (FLSA)

The FLSA sets federal rules for minimum wage, overtime pay, and recordkeeping. It requires you to pay non-exempt employees at least 1.5 times their regular rate for hours worked beyond 40 in a workweek. Some states set higher minimum wages and stricter overtime rules, so check your state's requirements too.

Federal Insurance Contributions Act (FICA)

FICA funds Social Security and Medicare through payroll taxes split between you and your employees. Each side pays 7.65%: 6.2% for Social Security (on wages up to $184,500 for 2026) and 1.45% for Medicare (on all wages). Employees earning over $200,000 in a year pay an additional 0.9% Medicare tax.

Federal Unemployment Tax Act (FUTA)

FUTA funds the federal unemployment insurance program. The tax rate is 6% on the first $7,000 of each employee's annual wages, but most employers pay an effective rate of just 0.6% after applying the state tax credit. Employers in credit reduction states may owe more; for 2026, California and the U.S. Virgin Islands are designated credit reduction states.

How to manage payroll

Once you understand payroll basics, you need to decide how to handle it. Most small businesses choose 1 of 2 approaches.

In-house payroll with software

Payroll software automates calculations, tax filings, and recordkeeping so you can run payroll yourself. This option works well if you:

• Want direct control over your payroll process
• Have straightforward payroll needs (few employees, standard pay structures)
• Prefer lower ongoing costs than outsourcing

Modern payroll software like Xero Payroll (via Gusto) handles tax calculations, generates pay stubs, files required forms, and syncs with your accounting system.

Hiring a payroll service or professional

Payroll services handle some or all of your payroll tasks for a fee. Consider this option if you:

• Have complex payroll needs (multiple states, varied pay structures, many employees)
• Want to reduce the time you spend on payroll administration
• Prefer having experts handle tax compliance

You can hire a payroll service provider, work with an accountant or bookkeeper, or use a professional employer organization (PEO) that handles payroll alongside other HR functions.

How much does payroll cost?

Payroll costs extend well beyond the wages you pay employees. Understanding the full picture helps you budget accurately and avoid surprises.

Employer on-costs

On top of every dollar you pay in wages, expect to spend an additional 15% to 20% on employer contributions. This includes your FICA match (7.65%), FUTA and SUTA taxes, workers' compensation insurance, and any benefits you offer (health insurance, retirement contributions, paid leave).

Payroll software costs

Do-it-yourself (DIY) payroll software typically costs $20 to $150 per month, plus a per-employee fee. This option gives you direct control over payroll while automating the complex calculations and tax filings.

Outsourcing costs

Full-service payroll providers charge $50 to $250 or more per month, plus per-employee fees. The exact cost depends on the number of employees, pay frequency, and features included. Outsourcing costs more upfront but saves time and reduces your compliance risk.

What are employee payroll responsibilities?

Employee payroll responsibilities include providing required tax information and verifying their pay is accurate. Your employees need to:

• Complete tax forms: fill out a W-4 and any state tax forms before starting work, which determines how much tax to withhold
• Report changes: notify you when their circumstances change (new address, marital status, or withholding preferences)
• Review pay stubs: check each pay stub to confirm pay, benefits, and taxes are reported correctly

Simplify payroll with Xero

Managing payroll doesn't have to be complicated. While there are calculations, deadlines, and forms to handle, the right tools can simplify the entire process.

With Xero Payroll (via Gusto), you can automate pay calculations, track employee hours, handle tax filings, and stay compliant. Focus on running your business while your payroll runs in the background. Get one month free.

FAQs on payroll

Here are answers to frequently asked questions about payroll.

What does it mean to make payroll?

Making payroll means having enough cash available to pay all your employees on payday. It reflects the business obligation to compensate workers on schedule.

What's the difference between payroll and a paycheck?

Payroll refers to the full system you manage as an employer, from setup through tax filing. A paycheck is a single output of that system: the payment an employee receives on payday.

What is the difference between exempt and non-exempt employees?

The classification determines whether you owe overtime pay. Misclassifying an employee as exempt when they should be non-exempt can result in back pay liability, IRS penalties, and potential lawsuits.

Do I need special software to run payroll?

Software isn't legally required, but it saves time and reduces errors by automating calculations, tax filings, and recordkeeping. For most small businesses, payroll software is the most practical and cost-effective option.

What happens if I make a mistake with payroll?

Payroll errors can result in IRS penalties, interest charges, and the cost of correcting tax filings. Acting quickly to fix mistakes helps you resolve issues with minimal impact.

Are independent contractors part of payroll?

Independent contractors aren't part of your payroll. You pay them as agreed and report payments of $600 or more on Form 1099-NEC, but you don't withhold taxes or pay employer contributions on their behalf.