How to Calculate Payroll for Small Business: Step-by-Step Guide (2026)

Payroll is one of those things that sounds simple until you actually do it.

You know what your employees earn. You know when they need to get paid. But between federal income tax, Social Security, Medicare, FUTA, SUTA, pre-tax deductions, post-tax deductions, and the paperwork that follows — a single payroll run can feel like a tax exam.

This guide breaks it all down. Step by step, with current 2026 rates, real formulas, and plain English explanations. Whether you're running payroll for the first time or just want to make sure you're not overpaying (or underpaying) the IRS, this is the guide to bookmark.

And if you just need a quick number right now? Use our free payroll calculator — plug in salary, state, and filing status, and get gross-to-net in seconds.

Before You Start: Payroll Setup Checklist

Before you can calculate a single paycheck, you need these in place:

Business-Side Requirements

• Employer Identification Number (EIN) — your business's tax ID, obtained from the IRS (free, takes minutes online)
• State tax registration — register with your state's tax agency for income tax withholding and unemployment insurance
• EFTPS enrollment — the Electronic Federal Tax Payment System is required for depositing federal payroll taxes
• Pay schedule established — weekly, bi-weekly (most common), semi-monthly, or monthly
• Workers classified correctly — employee vs. independent contractor. Misclassification triggers serious IRS penalties.

Employee-Side Requirements

• Form W-4 — tells you how much federal income tax to withhold based on the employee's filing status and adjustments
• Form I-9 — verifies employment eligibility (required within 3 days of hire)
• State withholding form — some states have their own version of the W-4
• Direct deposit authorization — bank account and routing number for electronic payment

Got all that? Good. Let's calculate some payroll.

**→ Quick calculation? Try our free payroll calculator**

Step 1: Calculate Gross Pay

Gross pay is what the employee earns before any taxes or deductions come out. The calculation depends on how they're paid.

For Hourly Employees

Formula:

```

Gross Pay = (Regular Hours × Hourly Rate) + (Overtime Hours × Overtime Rate) + Bonuses + Commissions

```

Example — Hourly employee, bi-weekly pay period:

Overtime rules: Federal law (FLSA) requires overtime pay at 1.5× the regular rate for hours worked over 40 in a workweek. Some states — like California — have stricter rules (daily overtime after 8 hours). Always check your state.

2026 update: Under the One Big Beautiful Bill Act (OBBBA), employees may be eligible for a federal income tax deduction on qualified overtime income (up to $12,500 for single filers, $25,000 married filing jointly). This deduction is taken on the employee's personal tax return — it doesn't change how you calculate withholding, but your 2026 W-2s will need new reporting codes for overtime premiums.

For Salaried Employees

Formula:

```

Gross Pay = Annual Salary ÷ Number of Pay Periods

```

Example — Salaried employee, bi-weekly:

Common pay period frequencies:

Step 2: Subtract Pre-Tax Deductions

Pre-tax deductions reduce the employee's taxable income — meaning they pay less in income tax and FICA (in most cases). Subtract these from gross pay before calculating any taxes.

Common Pre-Tax Deductions

Example — continuing with our salaried employee:

Step 3: Calculate Federal Income Tax Withholding

Federal income tax withholding is based on the employee's W-4 form and the IRS withholding tables (Publication 15-T). The amount depends on:

• Filing status (single, married filing jointly, head of household)
• Pay frequency
• Additional withholding requested on W-4
• Any credits claimed (Step 3 of W-4)

2026 Federal Income Tax Brackets (Single Filer)

In practice: You don't manually calculate from the brackets. Use the IRS percentage method from Publication 15-T or — much easier — use our payroll calculator which applies the current withholding tables automatically.

Example estimate: For our salaried employee earning ~$64,220 annually in taxable income (after pre-tax deductions), the approximate federal withholding per bi-weekly period is around $344.00 (using 2026 standard deduction of $15,700 for single filer, percentage method).

Step 4: Calculate FICA Taxes (Social Security + Medicare)

FICA taxes fund Social Security and Medicare. Both the employer and employee pay — you withhold the employee's share and match it.

2026 FICA Rates

Key 2026 change: The Social Security wage base increased to $184,500 (up from $176,100 in 2025). Maximum employee Social Security contribution: $11,439.

Example FICA Calculation

Using our taxable income of $2,470.00 for the pay period:

Remember: FICA is calculated on gross pay minus only Section 125 (cafeteria plan) deductions. 401(k) contributions reduce income tax but generally do NOT reduce FICA. For simplicity in this example, we're using the reduced figure, but check with your tax advisor on your specific plan structure.

Step 5: Calculate State and Local Taxes

State income tax withholding varies dramatically by location:

States With No Income Tax (2026)

Alaska, Florida, Nevada, New Hampshire (interest/dividends only), South Dakota, Tennessee, Texas, Washington, Wyoming

State Tax Examples

Important: Withhold based on where the employee works, not where your business is located. Remote employees in different states? You may need to withhold in multiple states.

**→ Factor in your state automatically — free payroll calculator**

State Unemployment Tax (SUTA)

SUTA is primarily an employer-paid tax (though a few states require employee contributions). Rates are assigned based on your company's claims history — new businesses start at a default rate.

Step 6: Calculate Federal Unemployment Tax (FUTA)

FUTA is an employer-only tax. You don't withhold it from employee wages.

2026 FUTA Details

FUTA is small per employee but adds up. For 10 employees, that's $420/year.

Step 7: Subtract Post-Tax Deductions

Post-tax deductions come out after all taxes are calculated. These include:

• Roth 401(k) contributions — taxed now, tax-free in retirement
• Wage garnishments — court-ordered deductions for child support, student loans, or debts
• Union dues
• After-tax insurance premiums — life insurance over $50K, disability in some cases
• Charitable contributions — voluntary payroll deductions

2026 note: Under the SECURE 2.0 Act, employees aged 50+ earning over $150,000 in the prior year must make 401(k) catch-up contributions on a Roth (post-tax) basis. This changes the deduction sequence for affected employees.

Step 8: Calculate Net Pay (Take-Home Pay)

Now bring it all together:

```

Net Pay = Gross Pay − Pre-Tax Deductions − Federal Income Tax − FICA (Employee) − State/Local Tax − Post-Tax Deductions

```

Full Example: Bi-Weekly Paycheck

Employee: Salaried, $65,000/year, single filer, Colorado, 6% 401(k), employer health plan

Employer's additional cost for this employee per pay period:

The real cost of a $65K employee is closer to $81K when you factor in employer-side taxes and benefits. That's important for budgeting.

Step 9: Pay Employees and Deposit Taxes

Paying Employees

• Direct deposit is standard (faster, cheaper, preferred by employees)
• Paper checks are an option but increasingly rare
• Provide pay stubs showing gross pay, all deductions, and net pay — required in most states

Depositing Federal Taxes

The IRS assigns you a deposit schedule based on your total tax liability:

Deposits are made through EFTPS (Electronic Federal Tax Payment System). Late deposits trigger penalties — 2% to 15% depending on how late.

Filing Requirements

Common Payroll Mistakes That Cost Small Businesses Money

1. Misclassifying Employees as Contractors

This is the most expensive payroll mistake you can make. If the IRS determines a worker you treated as a 1099 contractor should have been a W-2 employee, you owe:

• Back payroll taxes (employer and employee portions)
• Penalties and interest
• Potential benefits and overtime owed

The test: If you control *how* the work is done (not just *what* work is done), they're probably an employee.

2. Missing Tax Deposit Deadlines

EFTPS deposits are time-sensitive. Even being one day late triggers penalties:

Set calendar reminders or use payroll software that handles deposits automatically.

3. Calculating Overtime Incorrectly

Common errors:

• Not including bonuses and commissions in the "regular rate" for overtime calculation
• Using the wrong overtime threshold (40 hours/week federally, but some states differ)
• Averaging hours across two weeks for bi-weekly employees (you can't — overtime is calculated per workweek)

4. Ignoring State-Specific Rules

Every state has its own rules for:

• Minimum wage (often higher than federal $7.25)
• Overtime thresholds
• Pay frequency requirements
• Final paycheck timing (California requires immediate payment on termination)
• Paid leave mandates

5. Poor Record Keeping

The IRS requires you to keep payroll records for at least 4 years after taxes are due or paid (whichever is later). State requirements may be longer — up to 6 years in some cases.

Records to retain: timesheets, W-4s, I-9s, pay stubs, tax deposit receipts, W-2 copies, 941/940 filings.

6. Not Accounting for the OBBBA Changes in 2026

The One Big Beautiful Bill Act introduces new complexity:

• Tip income deductions (up to $25,000 for qualified tipped employees)
• Overtime income deductions (up to $12,500/$25,000)
• New W-2 reporting codes for tip and overtime premiums
• These deductions don't reduce FICA — only federal income tax on the employee's personal return

If you haven't updated your payroll process for OBBBA, you risk filing incorrect W-2s.

DIY Payroll vs. Payroll Software vs. Payroll Service: Which Is Right for You?

DIY Payroll (Manual)

Best for: Solo businesses with 1-2 employees, very tight budgets

Our recommendation: If you go DIY, at minimum use a payroll calculator to verify your math every pay period. One wrong FICA calculation compounds across the entire year.

Payroll Software

Best for: Small businesses with 3-50 employees who want automation without outsourcing

Full-Service Payroll Provider

Best for: Growing businesses, companies in multiple states, businesses that want zero payroll admin

When to Move Beyond DIY

You should seriously consider payroll software or a service when:

• You have 3+ employees
• You operate in multiple states
• You're spending more than 2 hours per pay period on payroll
• You've received a penalty notice from the IRS or state
• You're ready for proper accounting that connects payroll to your P&L

Holdings' Software plan ($25/mo) includes full double-entry accounting with invoicing, P&L statements, and balance sheets — giving you the financial backbone that makes payroll management make sense. When your books are organized, payroll reconciliation becomes straightforward instead of stressful.

Payroll Tax Calendar: Key 2026 Dates

Frequently Asked Questions

How do I calculate payroll taxes for a small business?

Payroll taxes include the employer and employee shares of FICA (6.2% Social Security + 1.45% Medicare = 7.65% each), federal income tax withholding (based on W-4 and IRS tables), FUTA (0.6% on first $7,000 — employer only), and state/local taxes. Use our free payroll calculator to get an instant breakdown for any salary and state.

What is the Social Security wage base for 2026?

The 2026 Social Security wage base is $184,500 — up from $176,100 in 2025. Employees and employers each pay 6.2% on wages up to this limit. Maximum employee Social Security tax: $11,439.

How much does it really cost to employ someone?

A good rule of thumb: add 20-30% on top of salary for employer-side taxes and basic benefits. For a $50,000/year employee, expect total employer cost of $60,000-$65,000. This includes employer FICA match (~$3,825), FUTA ($42), SUTA (varies), and any benefits you provide.

Can I do payroll myself without software?

Yes, but it's risky and time-consuming as you grow. For 1-2 employees in a single state, manual payroll with a calculator tool to verify your math is doable. Beyond that, the risk of errors, missed deadlines, and penalties outweighs the cost of software.

What happens if I make a payroll tax mistake?

File corrected forms as soon as you discover the error. Use Form 941-X to correct a previously filed Form 941. The IRS is more lenient when you self-correct promptly. Penalties for underpayment range from 2%-15% depending on how late the correction is.

What's the difference between payroll tax and income tax?

Payroll taxes (FICA) are flat-rate taxes that fund Social Security and Medicare — both employer and employee pay. Income tax is progressive (higher rates on higher income) and only the employee pays, based on their W-4. As an employer, you withhold both from paychecks and deposit them to the IRS on different schedules.

How do the 2026 OBBBA changes affect my payroll?

The One Big Beautiful Bill Act creates new federal income tax deductions for qualified tip income (up to $25,000) and overtime income (up to $12,500 for single filers). These deductions are claimed on the employee's personal tax return — not withheld by the employer. However, you'll need to use new W-2 reporting codes in 2026 to separately report tip and overtime premiums. Update your payroll system or talk to your provider about OBBBA compliance.

When should I hire a payroll service instead of DIY?

Consider a payroll service when you have 3+ employees, operate in multiple states, spend more than 2 hours per pay period on payroll, or if compliance complexity is keeping you up at night. The cost ($50-200/mo) is usually less than the penalty for one missed deposit.

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Take the Guesswork Out of Payroll

Payroll doesn't have to be stressful. Start with the right tools, understand the math, and stay on top of deadlines.

[Holdings' free payroll calculator](/tools/payroll-calculator) gives you instant gross-to-net calculations with current 2026 tax rates — federal, state, FICA, all of it. No signup. No spreadsheet formulas. Just accurate numbers.

For businesses ready to connect payroll to their full financial picture, Holdings Software ($25/mo) gives you double-entry accounting, invoicing with payment links, P&L statements, and balance sheets — so your payroll numbers flow into financial reports that actually make sense.

Free plan ($0/mo) includes 50+ free tools — including the payroll calculator, invoice generator, and free business banking.

**→ Calculate your next payroll — free**

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*Holdings is a financial technology company and is not a bank. Banking services provided by i3 Bank, Member FDIC. Deposits are FDIC insured up to $3,000,000 through i3 Bank and program banks.*