Texas Payroll Guide for Small Business Owners

Section 1: Texas Payroll Overview

Texas is one of nine states with no state income tax, which simplifies payroll in one important way: you do not withhold state income tax from employee paychecks. However, that does not mean Texas employers are off the hook for payroll compliance. Several federal and state obligations still apply.

What you are still required to do

• Federal income tax withholding — Based on each employee’s W-4 and IRS withholding tables (Publication 15-T).
• Social Security & Medicare (FICA) — Both employee and employer shares must be withheld and remitted.
• Federal Unemployment Tax (FUTA) — Employer-only tax on the first $7,000 of each employee’s wages.
• Texas Unemployment Insurance (TWC) — State unemployment tax administered by the Texas Workforce Commission.

Section 2: Setting Up Payroll in Texas

Getting payroll right from the start saves you from costly corrections later. Follow these seven steps in order before you run your first payroll.

1. 1

   Get your Employer Identification Number (EIN)

   Apply at IRS.gov. It’s free and you receive your EIN instantly online. You need this before you can hire employees, open a business bank account, or file payroll taxes.

2. 2

   Register with the Texas Workforce Commission

   Go to twc.texas.gov and create an employer account. You’ll receive a TWC account number, which you’ll use to file quarterly unemployment reports and pay state UI taxes.

3. 3

   Collect a W-4 from each employee

   The IRS Form W-4 tells you how much federal income tax to withhold. Employees complete it on or before their first day of work. Keep the original on file — do not send it to the IRS unless requested.

4. 4

   Verify employment eligibility with Form I-9

   Federal law requires you to verify that every new hire is authorized to work in the United States. Complete Section 1 on the first day of work; complete Section 2 within three business days.

5. 5

   Set your payroll schedule

   Texas law does not mandate a specific pay frequency, but you must pay employees at least twice a month (semimonthly) unless they are exempt employees. Common schedules: weekly, biweekly, semimonthly, or monthly.

6. 6

   Choose payroll software or a payroll service

   Manual payroll is error-prone and time-consuming. Payroll software automates tax calculations, generates pay stubs, and files forms electronically. See Section 9 for a comparison of popular options.

7. 7

   Open a dedicated payroll bank account

   Keep payroll funds separate from your operating account. This makes reconciliation easier, reduces the risk of accidentally spending tax funds, and simplifies audits.

Section 3: Federal Payroll Taxes

Federal payroll taxes are the same regardless of which state you operate in. As a Texas employer, these are your primary tax obligations.

Section 4: Texas Unemployment Insurance (TWC)

Texas unemployment insurance (UI) is administered by the Texas Workforce Commission. Unlike most states, Texas does not require employees to contribute to UI — it is an employer-only tax.

TWC tax rates

Quarterly reporting requirements

You must file a quarterly wage report and pay any UI taxes due by the last day of the month following the end of each quarter.

Section 5: Payroll Tax Deposit Deadlines

Missing a payroll tax deposit deadline triggers automatic IRS penalties that start at 2% and escalate quickly. Know your schedule and set calendar reminders.

Federal tax deposit schedule

Annual and quarterly filing deadlines

• Form 941 (Employer’s Quarterly Federal Tax Return) — April 30, July 31, October 31, January 31
• Form 940 (Annual FUTA Return) — January 31
• W-2s to employees — January 31
• W-2s to Social Security Administration — January 31
• TWC Quarterly Wage Report — April 30, July 31, October 31, January 31

Section 6: Employee vs. Independent Contractor

One of the most common — and costly — payroll mistakes is misclassifying employees as independent contractors. The IRS and the Texas Workforce Commission both scrutinize worker classification.

IRS three-factor test

Consequences of misclassification

If the IRS or TWC determines you misclassified an employee as a contractor, you may owe: all unpaid payroll taxes (both employee and employer shares), interest on unpaid taxes, penalties up to 100% of unpaid taxes, and back unemployment insurance contributions to the TWC.

Form 1099-NEC

If you pay an independent contractor $600 or more in a calendar year, you must issue a Form 1099-NEC by January 31 of the following year. File Copy A with the IRS and provide Copy B to the contractor.

Section 530 safe harbor

Section 530 of the Revenue Act of 1978 provides relief from employment tax liability for worker misclassification if you had a reasonable basis for treating the worker as a contractor, treated all similarly situated workers consistently, and filed all required 1099s.

Section 7: Payroll Records You Must Keep

Federal and state law require you to retain payroll records for specific periods. Inadequate recordkeeping is itself a compliance violation and makes audits far more painful.

Federal requirements

The IRS requires you to keep employment tax records for at least four years after the date the tax was due or paid, whichever is later.

• Form W-4 for each employee (keep while employed + 4 years after termination)
• Pay stubs and payroll registers (4 years)
• Time and attendance records (2 years under FLSA; 4 years recommended)
• Form I-9 (3 years from hire date or 1 year after termination, whichever is later)
• Payroll journals and general ledger entries (4 years)
• Federal tax deposit records and receipts (4 years)
• Copies of filed Forms 941, 940, W-2, W-3 (4 years)

Texas-specific requirements

The TWC requires you to retain records sufficient to support your quarterly wage reports. Keep copies of all TWC quarterly reports and payment confirmations.

Section 8: Common Texas Payroll Mistakes

These are the ten payroll mistakes we see most often when small business owners come to us for help. Each one is avoidable with the right systems in place.

1. 1

   Missing federal tax deposit deadlines

   IRS penalties start at 2% for deposits 1–5 days late and escalate to 15% after the first IRS notice. On a $10,000 deposit, a 15% penalty is $1,500 — for a single missed deadline.

2. 2

   Misclassifying employees as independent contractors

   The most expensive payroll mistake. Back taxes, penalties, and interest can easily exceed what you “saved” by avoiding payroll taxes and benefits.

3. 3

   Not registering with the Texas Workforce Commission

   You must register with the TWC before your first payroll. Operating without a TWC account means you’re not paying UI taxes — which creates back liability plus penalties when discovered.

4. 4

   Forgetting to file Form 941

   Form 941 is due quarterly even if you had no payroll activity that quarter. Failure to file triggers a 5% per month penalty on any unpaid tax, up to 25%.

5. 5

   Not updating W-4s when employees have life changes

   Marriage, divorce, a new child, or a second job can significantly change an employee’s withholding needs. Encourage employees to review their W-4 annually and after major life events.

6. 6

   Paying below federal minimum wage

   Texas follows the federal minimum wage of $7.25 per hour. Tipped employees may be paid $2.13 per hour if tips bring them to at least $7.25. Violations carry back pay liability plus damages.

7. 7

   Not tracking overtime correctly

   The Fair Labor Standards Act (FLSA) requires 1.5x the regular rate for all hours over 40 in a workweek for non-exempt employees. Misunderstanding the workweek definition or averaging hours across weeks is a common error.

8. 8

   Mixing payroll funds with the operating account

   Using a single bank account for payroll and operations makes it easy to accidentally spend tax funds. A dedicated payroll account with a separate tax withholding sub-account is best practice.

9. 9

   Not filing W-2s on time

   W-2s are due to employees and the SSA by January 31. Penalties range from $60 per form (filed within 30 days late) to $630 per form (intentional disregard). With 10 employees, intentional disregard penalties could reach $6,300.

10. 10

    Running payroll manually without reconciling

    Manual payroll is error-prone. Even small rounding errors compound over time. If you insist on manual payroll, reconcile your payroll register to your bank statement and tax deposits every single pay period.

Section 9: Payroll Software Options

The right payroll software automates tax calculations, handles direct deposit, files forms electronically, and integrates with your accounting software. Here is a comparison of the most popular options for Texas small businesses.

Section 10: When to Outsource Payroll

Many small business owners start by running payroll themselves. That works — until it doesn’t. Here are the signs it’s time to hand payroll off to a professional.

Signs it’s time to outsource

• You’re spending 4+ hours per month on payroll tasks
• You’ve missed a deposit deadline or received an IRS notice
• Your headcount is growing and payroll is getting more complex
• You’re adding independent contractors alongside employees
• You’re not confident your tax calculations are correct
• You’re spending time on payroll instead of running your business