There’s a specific kind of financial stress that hits freelancers and small business owners once they start hiring — even if it’s just one part-time contractor in another state. Suddenly, payroll isn’t a simple bank transfer anymore. There are withholding requirements, state tax registrations, contractor classifications, and quarterly filing deadlines that vary depending on where your worker actually lives and where your business is registered.
Most people discover these layers the hard way: a notice from a state tax authority, a misclassified contractor who files a complaint, or a quarterly filing that was missed because no one set up the account in the right state to begin with.
If you’re a freelancer who has started subcontracting work, or a solo operator transitioning into a small team, understanding how remote payroll actually functions — and what tools support it properly — is one of the most financially consequential decisions you’ll make. Getting it right from the start is significantly easier than cleaning up compliance problems after the fact.
Why Payroll Complexity Hits Freelancers Differently
Established companies have HR departments, legal counsel, and accounting teams to absorb payroll complexity. Freelancers and small operators don’t. Every decision lands directly on you.
The financial stakes are real and specific.
Tax liability follows work location, not business location. If you hire a subcontractor or part-time employee who works from a different state, that state may require you to register as an employer there, withhold state income taxes, and file quarterly returns — even if your business has no physical presence in that state. This catches many freelancers off guard.
Contractor vs. employee classification carries serious consequences. The IRS and state labor agencies apply specific tests to determine whether someone is a contractor or an employee. Misclassification — even when unintentional — can result in back taxes, penalties, and liability for unpaid employment taxes going back years. The financial exposure on a misclassification audit is rarely small.
Cash flow planning breaks down without accurate payroll costs. If you’re budgeting $3,000/month for a part-time worker at $25/hour, the actual cost to you as the employer is closer to $3,400–$3,600 once you account for the employer portion of FICA taxes (7.65%), any state unemployment insurance contributions, and workers’ comp premiums if applicable. Running lean projections without these figures creates cash flow gaps that compound over time.
Quarterly estimated taxes become harder to calculate. As a freelancer, you’re already managing your own estimated tax payments. Adding payroll — even for one person — introduces new variables. Employer tax deposits have their own schedules, separate from your personal estimated payments, and missing them triggers penalties that accumulate quickly.
What Payroll Software Actually Does at the Operational Level
A payroll platform isn’t just a payment tool. At the workflow level, it replaces a significant amount of manual compliance work that would otherwise fall entirely on you.
Tax Registration and Multi-State Compliance
When you hire someone in a new state, you typically need to register with that state’s department of revenue and department of labor before running the first payroll. Some payroll platforms handle this registration process on your behalf. Others provide guidance but leave the filings to you. Knowing which approach your platform takes matters before you hire, not after.
Once registered, the platform should automatically apply the correct state and local tax rates, update withholding tables when rates change, and generate state-specific forms at year-end alongside federal W-2s and 1099s.
Contractor and Employee Payment Separation
A well-configured payroll system keeps contractor payments and employee payroll in clearly separated workflows. Contractors are paid via direct transfer with 1099 tracking; employees go through a full payroll run with tax withholding, employer contributions, and pay stubs. Mixing these in a single unstructured system is one of the most common sources of year-end reporting errors for small operators.
Automated Tax Deposits and Filing
Federal payroll taxes — the employer and employee portions of Social Security and Medicare, plus federal income tax withholding — must be deposited on a schedule set by the IRS based on your total tax liability. New employers are typically monthly depositors. Missing a deposit date triggers a penalty that starts at 2% and increases the longer it’s outstanding.
Payroll platforms that handle tax deposits automatically remove this risk entirely. The deposit happens without you scheduling it manually.
Direct Deposit and Pay Stub Generation
These are the baseline features most people think of first, but they matter for compliance reasons beyond convenience. Pay stubs are legally required in most states and must include specific information about gross pay, deductions, and net pay. A platform that generates compliant pay stubs automatically protects you from state labor law violations that are easy to overlook.
A Realistic Numbers Scenario
Suppose you’re a freelance brand strategist earning $180,000/year. You’ve started subcontracting research and writing work to two people: one part-time employee working 20 hours/week at $28/hour, and one contractor you pay roughly $2,000/month for deliverable-based work.
Your part-time employee costs break down as follows on a monthly basis:
- Gross wages: approximately $2,240/month (20 hrs × $28 × 4 weeks)
- Employer FICA (7.65%): $171
- Federal unemployment (FUTA, annualized at 6% on first $7,000): approximately $35/month for the first few months
- State unemployment insurance: varies by state, typically $30–$80/month
- Total monthly employer cost: approximately $2,476–$2,526
Your contractor is simpler — $2,000/month, no withholding, but you must issue a 1099-NEC at year-end if total annual payments exceed $600.
Between these two workers, you’re spending approximately $4,500/month on labor. Without a payroll system tracking employer tax liabilities separately, it’s easy to treat that as a flat $4,240 expense and underestimate your actual cash outflow by $260–$300 every month — which adds up to $3,000–$3,600 annually in unplanned costs.
A payroll platform that handles both workers in one place, calculates employer contributions automatically, and separates the 1099 contractor workflow from the employee payroll run eliminates all of this manual reconciliation.
Choosing the Right Setup for Where You Are Now
The right payroll tool depends on your specific situation — the number of workers, their locations, and how much complexity you’re managing.
Solo freelancer with contractors only: If everyone you pay is a legitimate contractor, you may not need formal payroll software at this stage. A payment platform that tracks 1099 payments and generates year-end forms at low cost is often sufficient. The priority here is clean recordkeeping, not full payroll infrastructure.
Freelancer with one or two W-2 employees: This is where dedicated payroll software earns its cost immediately. The compliance overhead of running even one employee — multi-state registration, tax deposits, quarterly filings — is substantial enough that manual handling creates real risk. Tools like Gusto are built specifically for this profile: small headcount, simple benefits, straightforward multi-state handling.
Small agency or growing practice with five or more workers across multiple states: At this scale, the complexity of varying state tax rules, different worker types, and benefits administration justifies a more robust platform. Rippling or Justworks handle multi-state compliance more comprehensively and include HR features that become relevant as headcount grows.
Teams with international contractors: Standard US payroll platforms don’t cover international payments. For cross-border contractor payments, platforms like Deel or Remote handle local compliance in the contractor’s country — a separate and important consideration if you’re working with people outside the US.
Common Mistakes Freelancers Make With Payroll
Treating contractors and employees as interchangeable. The classification test isn’t about preference — it’s based on behavioral control, financial control, and the nature of the relationship. Paying someone like a contractor when the working relationship meets the criteria for employment is a compliance problem regardless of what you call it in your agreement.
Not registering in the worker’s state before the first payroll run. State registrations take time. Starting payroll before completing the registration process creates back-filing obligations and potential penalties. The registration should happen first.
Using personal bank transfers for contractor payments without tracking them. Venmo, Zelle, and bank transfers are fine payment methods, but only if every payment is logged with dates and amounts. Come January, reconstructing a year of untracked contractor payments to issue accurate 1099s is tedious and error-prone.
Underestimating the employer tax burden when budgeting for hires. The gross wage is not the total cost. Failing to account for employer-side FICA, FUTA, and state unemployment contributions consistently leads to tighter cash flow than projected.
Choosing a payroll tool based on price alone. The cheapest platform often requires the most manual involvement. For a freelancer without a dedicated bookkeeper, a slightly more expensive platform that handles tax deposits and filings automatically is usually the better financial decision when you factor in your own time and compliance risk.
Platform Comparison for Freelancers and Small Teams
| Platform | Best Fit | Core Strength | Limitation |
|---|---|---|---|
| Gusto | 1–10 employees, US-based | Simple setup, automated tax filings | Limited international support |
| Rippling | Growing teams, multi-state | Payroll + HR in one system | Higher cost at small headcount |
| Justworks | Small teams wanting PEO model | Benefits access, compliance support | Less flexible for custom setups |
| Deel | International contractors | Cross-border payments, local compliance | Not designed for US W-2 payroll |
| QuickBooks Payroll | Existing QuickBooks users | Accounting integration | Support quality inconsistent |
Frequently Asked Questions
Do I need payroll software if I only pay contractors?
Not necessarily. If your workers are legitimately classified as contractors and you’re tracking payments accurately for 1099 purposes, a simple payment tracking setup may be sufficient. Payroll software becomes essential once you hire a W-2 employee, because the tax deposit and filing requirements are significantly more complex.
If my contractor works from a different state, do I have tax obligations there?
For true independent contractors, generally no — the contractor handles their own taxes. The multi-state employer tax obligation typically applies to W-2 employees. However, if the nature of the working relationship meets the criteria for employment, the worker’s state may require you to register and withhold regardless of how the relationship is classified.
What’s the actual cost of running payroll for one part-time employee?
Beyond the gross wage, plan for roughly 8–12% in employer-side taxes and contributions depending on your state. A $2,500/month gross wage will realistically cost you $2,700–$2,800/month once employer FICA, FUTA, and state unemployment are included.
Can I run payroll myself without a dedicated platform?
Technically yes, but the manual process involves calculating withholding for each pay period, making timely federal and state tax deposits, filing quarterly 941s and state returns, and generating W-2s at year-end. For most freelancers, the compliance risk and time investment make a payroll platform the more practical choice at any headcount above zero.
When should I switch from a basic tool to a more comprehensive platform?
The clearest signals are: you’re hiring in a second state, you’re adding benefits, or your current tool is requiring you to manually handle things it should be automating. Each of those situations warrants re-evaluating your setup before the next payroll cycle, not after a compliance issue surfaces.
What to Do Before You Run Your First Payroll
The compliance foundation matters more than the tool you choose. Before selecting a platform, clarify the classification of every person you’re paying, confirm whether your business is registered in each state where your workers are located, and understand your federal tax deposit schedule.
Once that groundwork is in place, matching a platform to your actual headcount and complexity becomes a straightforward decision. For most freelancers starting with one or two workers, a platform that automates tax deposits and filings — even at a slightly higher monthly cost — is worth it for the compliance protection alone.
Set it up correctly at the start. The cost of fixing payroll problems retroactively is almost always higher than the cost of building the right system from the beginning.
