Hiring your first employee is a big step, and the payroll tax mechanics behind it are the part most owners underestimate. The federal and Texas systems are unforgiving, the penalties are mechanical, and small mistakes compound quickly. Here’s the working knowledge every Houston employer should have.
Employee vs. independent contractor
Before any of the payroll rules apply, you have to correctly classify the worker. An employee gets a W-2, has taxes withheld, and triggers your employer payroll tax obligations. An independent contractor gets a 1099-NEC at year-end if total payments exceed $600 and handles their own taxes. The IRS uses a multi-factor test centered on behavioral control, financial control, and the relationship between the parties. Misclassifying a worker who should be an employee as a contractor is one of the most expensive mistakes a small business can make — back taxes, penalties, and interest add up fast. When in doubt, classify as an employee.
The federal payroll taxes
For each employee, you’re responsible for:
- Federal income tax withholding: Calculated from the W-4 the employee submitted
- Social Security tax: 6.2% from the employee, 6.2% matched by you, on wages up to the annual cap ($168,600 for 2024)
- Medicare tax: 1.45% from the employee, 1.45% matched by you, no cap
- Additional Medicare tax: 0.9% withheld from employee wages over $200,000 (no employer match on this portion)
- FUTA (federal unemployment): 6.0% on the first $7,000 of each employee’s wages, but most employers get a 5.4% credit for paying state unemployment timely, leaving an effective rate of 0.6%. Paid quarterly, reported annually on Form 940
Texas-specific payroll taxes
Texas has no state income tax, which simplifies things compared to most states. But you still owe:
- Texas Unemployment Tax (SUTA): Administered by the Texas Workforce Commission. New employers start at a standard rate (around 2.7%), then move to an experience-based rate after a few years. Paid on the first $9,000 of each employee’s wages each year.
That’s the only state-level payroll tax. No state income tax withholding, no state disability, no local payroll taxes in Houston. Compared to California or New York, Texas payroll is genuinely simpler.
Deposit schedules
This is the part that gets people in trouble. Federal payroll tax deposits (income tax withholding plus Social Security and Medicare) are made on either a monthly or semi-weekly schedule based on your prior-year deposit history:
- Monthly depositor: Deposit by the 15th of the following month. Most small employers fall here.
- Semi-weekly depositor: Deposit by Wednesday for paychecks issued Wed-Fri, and by Friday for paychecks issued Sat-Tue. Larger employers.
- Next-day rule: If your accumulated tax liability hits $100,000 in any pay period, you owe the deposit the next business day. This catches growing businesses by surprise.
Late deposits trigger penalties of 2% (1-5 days late), 5% (6-15 days late), 10% (16+ days), or 15% (more than 10 days after the IRS notice). These add up faster than people expect.
Required filings
- Form 941: Quarterly federal payroll tax return. Due April 30, July 31, October 31, January 31
- Form 940: Annual federal unemployment return. Due January 31
- Form W-2: Annual wage and tax statement to each employee. Due January 31
- Form W-3: Transmittal that goes with W-2s to the Social Security Administration. Due January 31
- Texas C-3 (Quarterly Wage Report) and C-4 (Tax Return): Filed with the Texas Workforce Commission. Due April 30, July 31, October 31, January 31
- New hire reporting: Within 20 days of hiring, report to the Texas Office of the Attorney General
The trust fund recovery penalty
This is the rule that turns payroll problems into personal financial problems. The portions of payroll tax withheld from employee wages (income tax, the employee share of Social Security and Medicare) are considered “trust fund” taxes — you’re holding them in trust for the government. If the business fails to remit them, the IRS can pierce the entity and personally assess the responsible party (the owner, often). The Trust Fund Recovery Penalty is 100% of the unpaid trust fund taxes. There is no LLC or corporate shield against it. This is why payroll tax has to come out of every payroll cycle — not when the business has cash, every time.
Common mistakes I see
- Running payroll out of personal accounts because the business account is short
- Treating the Social Security and Medicare withheld as “cash flow”
- Misclassifying long-term contractors who should be employees
- Missing 941 quarterly filings (the IRS notices fast)
- Not registering with the Texas Workforce Commission when hiring the first employee
- Failing to issue W-2s by January 31
- Forgetting to track tip income for restaurants and salons
- Misclassifying owner’s draws as wages (or vice versa) in S-corps
Use real software
Don’t run payroll manually. Gusto, ADP, Paychex, and QuickBooks Payroll all handle federal and Texas calculations, deposits, and filings automatically for $40-$80/month plus per-employee fees. The cost is trivial compared to the consequences of a deposit error. Whatever you do, do not run payroll by writing a check from your business account and calling it “wages.”
S-Corp owner payroll — a special case
If you’ve elected S-corp status, the IRS expects a “reasonable” W-2 salary for the owner before profit distributions. The salary triggers all the payroll obligations above. The amount of the salary is one of the most-audited issues in S-corp returns — too low and the IRS will reclassify distributions as wages and assess back payroll tax. We help clients set and document reasonable comp every year as part of tax planning.
When to outsource
Most Houston small businesses I work with hand off payroll once they have more than two or three employees. The time savings, the compliance certainty, and the audit trail are worth far more than the monthly fee. We offer full-service payroll integrated with bookkeeping for clients who want it all in one place.
If you’re hiring your first employee soon — or you’ve been running payroll yourself and want a second set of eyes — call the office at (832) 983-7080 or use the contact page. We’ll review what you have, fix anything that needs fixing, and get you on a clean monthly cadence.