Hiring your first employee is an important milestone. It usually means your business is growing and you are ready to share the workload. However, becoming an employer also creates new tax, payroll, insurance, and recordkeeping responsibilities.
Before making the hire, it is important to understand the full cost of an employee and prepare the necessary systems. Proper planning can help you avoid missed filings, payroll problems, unexpected expenses, and penalties.
Make Sure You Are Hiring an Employee
The first step is determining whether the worker should be classified as an employee or an independent contractor. The classification is based on the actual working relationship, not simply the title given to the worker or the type of agreement they sign. A worker may be an employee when the business controls what work is performed, how it is completed, when it is completed, or where the person works. Employees may also use the company’s equipment, receive ongoing training, work regular hours, or perform services that are central to the business.
Independent contractors are generally responsible for how they perform their work. They may provide services to multiple clients, use their own equipment, set their own schedule, and operate an independent business.
The distinction matters because employers must generally withhold and pay payroll taxes for employees. Independent contractors typically handle their own income and self-employment taxes. Misclassifying an employee as an independent contractor may result in back taxes, penalties, interest, wage claims, and other liabilities.
California businesses must be especially careful. California generally uses a stricter standard for worker classification, and a worker may need to satisfy the state’s requirements before being treated as an independent contractor.
Calculate the True Cost of Hiring
An employee costs more than their hourly wage or annual salary. Before making an offer, prepare a realistic employment budget.
In addition to regular wages, the business may be responsible for:
- The employer’s portion of Social Security and Medicare taxes
- Federal and state unemployment taxes
- Workers’ compensation insurance
- Payroll processing and bookkeeping expenses
- Paid sick leave, vacation, or holiday pay
- Health insurance or retirement benefits, if offered
- Overtime and required meal or rest-period costs
- Equipment, software, supplies, and training
- Recruiting and background-check expenses
For example, an employee earning $25 per hour costs the business more than $25 per hour after payroll taxes, insurance, paid time off, and administrative expenses are included.
The employee’s wages and most related employment expenses are generally deductible business expenses. However, the business still needs enough available cash to cover payroll and make payroll tax deposits on time.
Obtain an Employer Identification Number
Businesses with employees generally need a federal Employer Identification Number, commonly called an EIN. This number is used to identify the business when filing payroll tax returns, making payroll tax deposits, and issuing wage statements. An EIN can be obtained directly from the IRS at no charge. Business owners should avoid third-party websites that charge unnecessary fees for obtaining one.
A business may also need to register with its state employment or tax agency. In California, a business must generally register with the Employment Development Department after becoming subject to California payroll tax requirements. Registration provides the employer with a state payroll tax account number.
Set Up a Payroll System
Payroll involves more than writing an employee a check. The employer must calculate gross wages, withholding, employer payroll taxes, deductions, and net pay. The business must also maintain payroll records, issue pay statements, deposit taxes, and file payroll returns.
Many small businesses use a payroll service because employment tax deadlines can vary. The deposit schedule may depend on the amount of payroll taxes reported during an earlier period. State filing and payment schedules may also differ from federal schedules.
A payroll system should be established before the employee’s first paycheck. Waiting until payday to determine how much to withhold can create errors and late deposits. Even when a payroll company prepares the returns and deposits, the employer remains responsible for making sure payroll information is accurate and filings are completed.
Complete the New-Hire Paperwork
New employees must complete certain forms when they begin working. The employee generally completes Form W-4 so the employer can calculate federal income tax withholding. A state withholding form may also be required.
Every U.S. employer must also complete Form I-9 to verify the employee’s identity and authorization to work in the United States. The employee must complete the applicable employee section no later than the first day of employment. The employer must generally review the employee’s documents and complete its section within three business days of the employee’s first day.
Form I-9 is retained by the employer and is not routinely submitted to the IRS. It must be stored securely and made available if requested by an authorized government agency.
Report Your New Employee
Employers are generally required to report newly hired employees to the appropriate state agency. Each state has its own reporting procedure and deadline.
California employers must generally report new and rehired employees to the California New Employee Registry within 20 calendar days of the employee’s start date. This is commonly completed using Form DE 34 or through the EDD’s electronic filing system.
A California business may also need to provide the employee with required wage, workers’ compensation, paid sick leave, and workplace-rights notices. Local requirements may apply depending on where the employee works.
Understand Employment Taxes
Employers generally withhold federal income tax from an employee’s wages based on the employee’s Form W-4. The employer must also withhold the employee’s portion of Social Security and Medicare taxes and pay a matching employer portion.
Federal payroll responsibilities may include:
- Withholding federal income tax
- Withholding Social Security and Medicare taxes
- Paying the employer’s share of Social Security and Medicare taxes
- Paying federal unemployment tax
- Depositing payroll taxes
- Filing quarterly employment tax returns
- Filing an annual federal unemployment tax return
- Providing Form W-2 to the employee
- Filing wage information with the Social Security Administration
California payroll obligations may include Unemployment Insurance, Employment Training Tax, State Disability Insurance withholding, and California Personal Income Tax withholding. California employers generally file quarterly wage and payroll tax reports even for certain quarters in which no wages were paid.
Payroll taxes held back from an employee’s wages are considered trust fund taxes. These amounts belong to the government and should never be used to pay other business expenses. In some circumstances, individuals responsible for failing to pay trust fund taxes can be held personally liable.
Purchase Workers’ Compensation Insurance
Workers’ compensation insurance helps cover employees who suffer a job-related injury or illness. Requirements differ by state, but many states require coverage as soon as a business hires its first employee. California generally requires employers to carry workers’ compensation insurance even when the business has only one employee. This requirement may apply whether the employee is full-time or part-time.
Business owners should arrange coverage before the employee begins working.
Create a Written Employment Offer
A written offer can help the employer and employee understand the basic terms of the position. The offer should generally explain the job title, start date, compensation, expected schedule, work location, and any benefits being offered. The offer should also state whether the position is full-time or part-time and whether it is classified as exempt or nonexempt. If employment is at will, that should be addressed using language appropriate for the employer’s state.
A job description is also useful. It should explain the employee’s responsibilities, reporting structure, performance expectations, and any physical or scheduling requirements of the position.
Prepare Workplace Policies
Even a business with one employee should establish basic workplace policies. Written policies create consistency and make expectations easier to communicate.
Depending on the business, policies may address:
- Work hours and attendance
- Timekeeping and overtime approval
- Meal and rest periods
- Paid sick leave and vacation
- Expense reimbursements
- Confidentiality and data security
- Use of business equipment
- Remote work
- Harassment and discrimination
- Workplace safety
- Discipline and termination
Employers may also be required to display federal, state, and local workplace posters. The specific posters depend on the business, workforce, and location. Remote employees may need to receive required notices electronically or through another permitted method.
Keep Business and Payroll Records
Accurate records are essential once a business begins paying employees. Payroll records should show how each paycheck was calculated, including hours worked, gross pay, withholding, deductions, and net pay.
Plan for Cash Flow
Payroll dates arrive whether customers have paid the business or not. Before hiring, consider whether the business can consistently cover wages, employer taxes, insurance, and operating expenses during slower periods. It may be helpful to maintain a separate payroll account and transfer sufficient funds into it before each payroll period. The employer should also monitor payroll tax withdrawals and confirm that deposits have cleared.
Hiring too early can place pressure on cash flow, but waiting too long can prevent the business from growing. A reasonable forecast can help determine whether the business is ready for a permanent employee, a part-time employee, or temporary help.
Getting Professional Help
Hiring your first employee changes your responsibilities as a business owner. A payroll company can help calculate wages and file payroll returns, while a tax professional can help explain employer tax obligations and coordinate payroll information with the business’s tax return.
An employment attorney or qualified human resources professional can assist with worker classification, offer letters, employee policies, wage-and-hour compliance, and state-specific requirements.
Setting up these systems before the employee starts is usually easier and less expensive than correcting payroll or compliance problems later.
Final Thoughts
Your first employee can give you the time and support needed to grow your business. The key is to treat the decision as more than a hiring expense. You are also taking on payroll, tax, insurance, recordkeeping, and workplace responsibilities. With a realistic budget and the proper systems in place, hiring your first employee can become an exciting and manageable step forward.
Disclosure: This article is provided for general informational purposes only and does not constitute tax, legal, payroll, insurance, or employment advice. Federal, state, and local requirements may change and can vary based on the business, employee, industry, and work location. Consult a qualified tax professional, payroll provider, insurance professional, or employment attorney regarding your specific circumstances.