How Payroll Works for California Small Businesses

Payroll is the process of calculating and paying your employees' wages, and sending the required taxes to both the IRS and California's Employment Development Department (EDD) on their behalf. California has some of the most complex payroll rules in the country. Missing a deposit or calculating withholdings incorrectly has real consequences: federal and state penalties, interest, and potential personal liability.

The Core Concept: Payroll Taxes and Withholdings

When you pay an employee, you don't just pay them their gross salary. You withhold taxes from their paycheck and also pay employer-side taxes on top of their wages:

Tax	What it is	Who pays it
Federal Income Tax	Withheld based on the employee's W-4	Employee only
Social Security (OASDI)	6.2% up to the annual wage base ($168,600 in 2024)	Employee and employer each pay 6.2%
Medicare	1.45% on all wages; +0.9% Additional Medicare Tax on wages over $200,000	Employee and employer each pay 1.45% (employer does not pay the additional 0.9%)
California PIT	California income tax withheld based on the employee's DE 4	Employee only
SDI (State Disability Insurance)	1.1% of wages (2024); no wage cap	Employee only
SUI (State Unemployment Insurance)	Varies 1.5% to 6.2% on first $7,000 of wages per employee per year	Employer only
ETT (Employment Training Tax)	0.1% on first $7,000 of wages per employee per year	Employer only

Social Security, Medicare, federal income tax, SDI, and California PIT are withheld from the employee's paycheck. SUI and ETT are employer-only costs, the employee never sees them deducted.

The Payroll Cycle

Calculate gross pay, the employee's hours or salary for the period
Calculate withholdings, federal income tax, Social Security, Medicare, California PIT, SDI (payroll software handles this automatically)
Pay the employee, net pay (gross minus all withholdings)
Deposit federal payroll taxes, Social Security, Medicare, and federal income tax on the IRS schedule (see below)
File quarterly federal return, Form 941
File quarterly California return, Forms DE 9 and DE 9C with the EDD
Issue W-2s at year-end, summary of wages and withholdings for each employee

Deposit Schedules

Federal (IRS):

Your deposit schedule depends on your total payroll tax liability in the prior lookback period (July 1 through June 30):

Monthly depositor: Liability was $50,000 or less, deposit by the 15th of the following month
Semi-weekly depositor: Liability was over $50,000, deposit on Wednesday or Friday based on your payday

New employers are automatically monthly depositors for their first year.

California (EDD):

EDD taxes are due quarterly, same deadlines as Form 941: April 30, July 31, October 31, and January 31.

California-Specific Rules to Know

Minimum wage: $16/hour statewide in 2024. Many cities are higher, Los Angeles is $17.28, San Francisco is $18.67. The wage that applies is whichever is highest for where the employee works.

Overtime: California's overtime rules are stricter than federal:

Time-and-a-half after 8 hours in a single workday (not just 40 hours in a week)
Double-time after 12 hours in a workday
Time-and-a-half on the 7th consecutive day in a workweek; double-time after 8 hours on that 7th day

Final paycheck: If you terminate an employee, their final paycheck is due immediately on their last day. If they resign without notice, you have 72 hours.

Pay stubs: California requires detailed pay stubs showing gross wages, all deductions, net pay, hours worked and pay rates, YTD totals, and your business name and address.

Workers' compensation: Mandatory for all employees before the first day of work. You cannot legally hire in California without it.

W-4 and DE 4: Employees must complete both a federal W-4 (federal withholding) and a California DE 4 (state withholding) before their first paycheck.

Payroll vs. Contractor Payments

Payroll rules apply to employees. If you pay contractors, you don't withhold or remit taxes, contractors handle their own. However, California uses the strictest contractor classification standard in the country (the ABC test under AB5), and misclassifying an employee as a contractor is a serious compliance risk. See: Employee vs. Contractor: What's the Difference and Why It Matters.

Abnormal Procedures

You hired your first employee and aren't registered with the EDD.

Register as an employer with the EDD before your first payroll run at edd.ca.gov. You'll also need an IRS Employer Identification Number (EIN) if you don't already have one. Your NCO team can walk you through the registration process.

You made a payroll error, wrong amount, wrong withholdings.

Payroll corrections need to be handled carefully, especially if they cross pay periods or calendar years. See: How to Handle a Payroll Correction. Don't just adjust the next paycheck without documentation.

You have employees working in multiple states.

Each state has its own income tax withholding rules, unemployment insurance requirements, and employment standards. Payroll software must be configured for the correct state of employment for each employee. Talk to your NCO advisor before running payroll across state lines.

FAQ

Do I need payroll software?

For more than one or two employees, yes. Manual payroll calculation is error-prone and time-consuming. QBO Payroll, Gusto, and ADP are common options. Your NCO team will recommend what fits your size and setup.

Does payroll apply if I'm the only employee paying myself a salary from my corporation?

Yes. If you're a corporation paying yourself a salary, payroll rules apply, you need to withhold taxes from your own wages and remit them, just like any other employee. Talk to your NCO advisor about the right mix of salary vs. distributions for your situation.

What happens if I miss a deposit deadline?

The IRS charges a failure-to-deposit penalty starting at 2% (scaling up based on how late the deposit is). California's EDD has its own penalties. Make the deposit as soon as possible to stop additional penalties from accruing, then contact your NCO advisor.

What is the difference between filing Form 941 and making payroll tax deposits?

Deposits are made throughout the quarter (monthly or semi-weekly) and represent the actual tax payments. Form 941 is the quarterly return filed with the IRS that reports your total wages, withholdings, and deposits. You do both, deposits during the quarter, then Form 941 at the end.