Soil organic matter is the largest terrestrial carbon pool1. The pool size depends on the balance between formation of soil organic matter from decomposition of plant litter and its mineralization to inorganic carbon. Knowledge of soil organic matter formation remains limited2 and current C numerical models assume that stable soil organic matter is formed primarily from recalcitrant plant litter3. However, labile components of plant litter could also form mineral-stabilized soil organic matter4. Here we followed the decomposition of isotopically labelled above-ground litter and its incorporation into soil organic matter over three years in a grassland in Kansas, USA, and used laboratory incubations to determine the decay rates and pool structure of litter-derived organic matter. Early in decomposition, soil organic matter formed when non-structural compounds were lost from litter. Soil organic matter also formed at the end of decomposition, when both non-structural and structural compounds were lost at similar rates. We conclude that two pathways yield soil organic matter efficiently. A dissolved organic matter–microbial path occurs early in decomposition when litter loses mostly non-structural compounds, which are incorporated into microbial biomass at high rates, resulting in efficient soil organic matter formation. An equally efficient physical-transfer path occurs when litter fragments move into soil.