Gross-to-Net Payroll Guide [2026]

You must pay yourself a reasonable W-2 salary. Determine reasonable compensation using comparable salary data from BLS, Glassdoor, or industry surveys for someone doing your role at a company of your size. The IRS scrutinizes situations where an S-Corp owner takes a low salary and high distributions to avoid payroll taxes. Typical guideline: 40–60% of S-Corp profit as salary, remainder as distributions. Run payroll for yourself just as you would for any employee — withholding rules are the same. The reasonable salary standard is facts-and-circumstances: your role, hours worked, industry norms, and what you'd pay someone else to do your job.

Accept the W-4 as submitted. You are not responsible for verifying the accuracy of an employee's W-4 — unless the IRS sends you a “lock-in letter” (Letter 2808C or 2809C) that mandates a specific withholding amount. At that point, you must follow the lock-in, not the W-4. The employee bears responsibility for any under-withholding, not you. Reminder: exempt W-4s expire each February 15, and the employee must submit a new W-4 annually to maintain exempt status. If no new W-4 arrives by February 16, withhold as single with no adjustments.

Withhold state income tax for the state where the employee physically works, not where your business is headquartered. You must register for payroll tax accounts in that state. Some states have reciprocal agreements: if an employee lives in one state and works in another, you may only need to withhold for the resident state (e.g., NJ and PA, MD and VA). Without reciprocity, the employee typically files a non-resident return in the work state and claims a credit in their home state. Remote work complicates this — some states have convenience-of-the-employer rules that may require withholding even if the employee works from home in another state for their own convenience. Consult a payroll professional when crossing state lines.

Failure-to-deposit penalty: 2% for 1–5 days late, 5% for 6–15 days, 10% for 16+ days, and 15% if the IRS issues a notice of levy. Interest accrues on top of these penalties. More critically, the Trust Fund Recovery Penalty (TFRP) under IRC Section 6672 makes responsible persons — owners, officers, directors — personally liable for the employee portion of withheld taxes that were collected but not remitted. This is the “trust fund” portion (income tax and the employee half of FICA). TFRP liability is not dischargeable in bankruptcy. The IRS can assess the penalty against multiple individuals. Never, ever use withheld payroll taxes as a short-term loan to your business.

Two methods for federal withholding on supplemental wages (bonuses, commissions, severance): Percentage method: flat 22% federal withholding (increases to 37% for supplemental wages over $1 million in a calendar year). Aggregate method: combine supplemental wages with regular wages and use standard withholding tables. Most employers use the flat 22% method — it's simpler and prevents an anomalous single paycheck from being withheld at a much higher rate. This covers federal only. State supplemental withholding rules vary: some states have flat rates, others require aggregation. Check your state revenue department for specific guidance.