Running payroll in the United States

Payroll processing in the US can be a real challenge for both local and foreign companies. Different rules and regulations apply on federal, state and local level and employers must comply with all of them in order to avoid fines.  

Further aspects which can make US payroll difficult to navigate for foreign companies is the variety of filing requirements linked to federal and state income tax and social security payments and the alternative minimum tax system which needs to be applied to employee income under certain circumstances.

Before they can start processing payroll, companies need to register as an employer with the federal as well as with the competent state (and municipal) authorities. The latter is necessary for every jurisdiction where they pay salaries and wages and are thus required to withhold income tax on behalf of the local authorities. 

Rules and regulations for employer registrations on municipal and state level vary greatly, but employers generally have to register with the state Department of Revenue for tax payments and with the state Department of Labor for unemployment insurance payments. New hires must be declared to the competent state authority - or, in some cases, directly to the Federal Office. 

On the federal level, the registration is processed by the Internal Revenue Service (IRS), which is the federal tax authority of the US. In order to complete the application, employers must name an individual with either a US social security number or a US tax number as the legally liable person for tax obligations. The relevant form is the SS-4. Alternatively, the registration can be done online. After registration, the employer obtains an employer identification number (EIN). A separate registration with the Social Security Administration (SSA) is not necessary.

It is necessary to set up a local bank account to issue payments to employees hired in the US under a local entity. Payments to US authorities can be issued through the Electronic Federal Tax Payment System (EFTPS).

Income tax in the US is levied at three different levels, namely on federal, state and local level. The tax system is progressive with federal rates going up to 37%. There are five different categories of taxpayers which determine the respective income thresholds for tax calculation. Social security contributions are made by both employee and employer.

Tax considerations

Federal tax rates in the US are progressive and range between a 9% base rate and a 37% top rate. The thresholds separating the different tax bands vary depending on the taxpayer’s family status. The different categories under which taxpayers are classified are single, married filing jointly, married filing separately, head of household and qualifying widow(er). 

On top of the federal income tax, employees are also subject to state income tax - this applies in most states with the exception of Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming - and may even have to pay additional local taxes - depending on the respective municipality. 

Furthermore, there is an alternative minimum tax (AMT) which is applied in cases where the individual’s regular tax levy would be lower than the AMT levy. AMT is levied at a 26% rate on the income share exceeding USD 118,100 for married couples and USD 75,900 for other taxpayers - a higher rate of 28% applies to individual income exceeding USD 206,100. Thresholds are valid for 2022.

An employee’s taxable income includes their regular salary and wages as well as bonuses and certain other payments. However, taxation of bonuses and other recognized equity compensations such as stock options may vary. Personal living or travel-related allowances are usually exempt from tax. Contributions made by the employee to an additional pension fund are partially deductible.

There is a standard tax allowance for employees and other taxpayers which is currently (as of 2022) set at USD 12,950 for singles and USD 25,900 for married couples which file their tax return jointly. Alternatively, it is possible to opt for itemized deductions which may include medical expenses, childcare expenses, mortgage payments and more. Employment expenses are no longer deductible since 2018. Further tax credits are available, including a tax benefit for employees with dependent children. 

US tax residents - including those living outside the US - are subject to (federal) income tax on their worldwide income. Non-residents, on the other hand, only pay (federal) tax on income sourced in the US as well as on so-called ECI (Effectively Connected Income), which is income earned from business and employment activities directly linked to the US. However, many states within the US also levy tax on non-residents. 

Tax residency is determined by different criteria. These include a “substantial presence” in the country over a certain period of time - i.e. either 183 days within one calendar year, or at least 31 days within one calendar year and a total of 183 days accumulated during three subsequent calendar years including the current year - as well as permanent lawful residence in the US via citizenship or immigration.

Tax withholding and reporting

Income tax from employment income is withheld at source by the employer. This includes federal, state and local income tax. For federal income tax, payments must be made to the IRS on a quarterly basis. Payments are usually due by the 15th of the month following the quarter in question. A Quarterly Federal Tax Return (Form 941), which details the amount of salaries, income tax and social taxes paid, is due by the end of the month following the quarter to which the payments relate, i.e. 30 April for the first quarter of the year. 

Once a year, employers further have to prepare an Annual Wage and Tax Statement (Form W-2), including paid amounts of wages, income tax and social security contributions. The W-2 Form needs to be sent to the IRS as well as to each employee. The deadline is 31 January of the following year. In parallel, the so-called Transmittal of Wage and Tax Statements (W-3) needs to be prepared for the Social Security Administration (SSA). 

Payment and filing requirements and schedules for state tax vary from state to state. Employees have to file an individual tax return by the 15th of April. The tax year is the calendar year.

Social security contributions

Although social protection in the US is not as extensive as in most European countries, there still are several social taxes to be paid by the employee and the employer. Payments go to two major bodies, which are the Medicare system (insurance against hospitalization) and the OASDI (old age pension, survivors benefits and disability insurance), which are summarized under the FICA tax (Federal Insurance Contribution Act tax).

The Medicare contribution rate is 2.9% of the employee’s total remuneration and is split between employees and employers. A 0.9% Medicare surcharge applies to income exceeding USD 250,000 for married couples and USD 200,000 for single taxpayers. OASDI contribution is levied at a rate of 12.4%, i.e. 6.2% for both employee and employer. However, the contribution base is limited to the first USD 147,000 of the employee’s earnings (valid in 2022). Social security contributions are not deductible from the employee’s taxable income. 

Furthermore, employers have to contribute to the federal unemployment insurance (FUTA) which amounts to 6% of the first USD 7,000 of the employee’s salary / wages. An additional unemployment tax is payable on state level (so-called SUI) at varying rates. Some states levy further contributions or require employers to take out occupational accident insurance for their employees. Companies employing more than 50 employees are also required to provide at least basic health insurance coverage for their employees. 

As FICA payments are included in the quarterly and annual tax reports which are also forwarded to the SSA, employers have no further filing obligations with regard to social security on the federal level, except for the Annual Federal Unemployment Tax Return (Form 940) which details the employer’s yearly FUTA contributions and which needs to be filed by 31 January of the following year. Payments generally have to be made quarterly. The payment date is the last day of the month following each quarter. The same deadlines apply for the quarterly SUI (state unemployment insurance) returns.

* Please note that there is a 0.9% surcharge on income exceeding certain thresholds. 

Despite the non-committal nature of employment agreements in the US and the resulting freedom for employers to handle employment, employees are entitled to several benefits under either federal or state law. These include:

• Annual leave and public holidays: no regulation on the federal level, but many states mandate a minimum amount of PTO which must be granted to employees; 10 federal public holidays, but no obligation to provide employees with pay on these days

• Maternity / Paternity / Parental / Sick leave: up to 12 weeks of unpaid leave per year are available for different medical and family-related reasons for employees who are eligible under the Family and Medical Leave Act (FMLA); further legal provisions for leave may exist on state and municipal level (especially with regard to maternity leave)

For more information on employee benefits and other employment requirements in the United States (including severance pay and termination procedures), check out our Global Hiring Guide.

As for other employment obligations, compensation requirements are also highly dependent on state regulations. Although there is a federal minimum wage which is currently (as of 2022) set at USD 7.25 per hour, many states set their own minimum wages. For detailed information on minimum wage requirements on state level, refer to the website of the US Department of Labor. Overtime work must be paid at a rate of 150% of the employee’s usual wages under federal law. Again, overtime pay regulations may be different on state level. Bonus payments are not legally required.

There is no regulation on the federal level as to how often employees must be paid. Instead, payment frequency is usually governed by state laws. The most common pay frequencies are bi-weekly or weekly, followed by semi-monthly and monthly. The general method for paying wages is either by cash or cheque, although bank transfer payments are possible with the employee’s written consent. 

Whether or not the employer is obligated to issue a payslip at the end of the pay period depends on the local regulations applicable in the respective state. In most states, employers have to issue a payslip detailing payroll-related information such as the total amount of hours worked, regular salary, overtime pay and more. Where required, payslips can usually be issued either in digital or paper form. Employers must keep payroll records for at least 3 years.