Small businesses hire nearly half of all private sector employees in the United States, with about 61.6 million people working for more than 33 million businesses across the country, according to the U.S. Small Business Administration (SBA).
If you’re a small business owner who has hired one or more employees, or you’re getting ready to add a new employee, you should be aware of some rules that apply to hiring and paying workers. Let me walk you through some important legal requirements to help you avoid mistakes when hiring employees.
1. Obtain an EIN
Before hiring one or more employees, you’ll need to get your payroll set up. One of the first steps in setting up payroll processing is obtaining an Employer Identification Number (EIN), which is a nine-digit number the IRS assigns to businesses for tax filing and reporting purposes. It is similar to a Social Security number for an individual. All businesses that hire employees must have an EIN, even if the business is a Sole Proprietorship or a General Partnership and not registered with the state.
To obtain an EIN, you’ll need to file a Form SS-4, which is an online application with the IRS. The person applying for the EIN is known as the responsible party, and must have a valid taxpayer identification number, such as a Social Security number or a previous EIN. Once you begin the application, you need to complete it in one session. If you’re inactive for more than 15 minutes, your session will expire, and you’ll need to start over. There’s no penalty if you do need to start again, but it will delay the application. If for some reason you can’t complete the application online you can fax or mail it to the IRS, but that will increase the processing time.
You can also save time by asking CorpNet to obtain the EIN for you.
2. Register for Payroll Taxes
Payroll taxes are federal and state taxes that employers are required to deposit and report on behalf of their employees. Also called employment taxes, they include withholding from employees’ paychecks to cover federal—and when applicable—state and local income taxes.
Payroll taxes also include the employees’ and employer’s shares of Social Security and Medicare taxes, also known as FICA taxes, and federal unemployment taxes, known as FUTA taxes and paid by the employer. Created by the Federal Unemployment Tax Act, FUTA taxes are paid to states to help workers who have lost their jobs. Many states collect an additional unemployment tax from employers under the State Unemployment Tax Act (SUTA). Employers who pay both FUTA and SUTA taxes may qualify for a discount on the federal tax.
When processing payroll, employers are responsible for the following tasks:
- Calculating income tax withholding and other employment taxes. How much an employee has withheld from their paycheck depends on the information they provide on their W-4 form, their salary, and deductions. Using those factors, you can determine the correct deduction needed to cover the taxes. If an employee earns $45,000 a year and reports they’re in a 10% tax bracket, for example, you’d have to deduct $450 from each pay to cover payroll taxes.
- Deposit all payroll taxes at scheduled times. Requirements for making the deposits vary depending on your business and the amount you withhold. Federal tax deposits must be made by electronic funds transfers.
- Submit quarterly (or annual for certain, small employers) reports about all employment taxes withheld, including income tax and FICA taxes.
- Finish other reporting, as required. This could include reporting on state or local taxes and filing annual federal income tax reports.
Employers must use a variety of tax returns when filing employment taxes. All employers need to file Form 940, which is the annual FUTA tax return, and Form 941, which is an employer’s quarterly tax return reporting withholding and the employer’s share of FICA taxes. Employers must provide employees with Form W-2, which reports how much was withheld from their paychecks, and Form W-3, a transmittal form that summarizes all W-2 forms, to the Social Security Administration. Other forms must be filed in certain instances, such as for agricultural employees or for small employers who pay employment taxes just once a year instead of having to adhere to a deposit schedule.
While payroll taxes can seem complicated, it’s imperative that employers understand what’s required of them and make sure the taxes are withheld, deposited, and reported correctly to avoid penalties, interest, and even criminal prosecution and possible jail time. If you are unsure about your ability to handle payroll taxes, a tax professional, payroll service, or other professional can help.
Register for Payroll Taxes With CorpNet
CorpNet can quickly register your new business for state payroll taxes. Our specialists manage the process of registering your new business for State Unemployment Insurance Tax (SUI) and State Income Tax (SIT), which saves you time and money.
3. Obtain a State Tax ID Number
If your state has a state income tax, you’ll need a state tax identification number. Seven states (Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming) have no income tax, and two states (Tennessee and New Hampshire) only tax income from dividends and interest. Companies in all other states will need to pay income tax, and in some states, employment taxes, as well. The SBA offers assistance for determining the need for a state tax ID number, or you could consult an accountant or attorney. If you need a state tax ID number, the process is similar to obtaining an EIN, but it varies from state to state.
4. Review Your Company’s Nexus Status in Other States
If your company has connections to another state, you may be responsible for collecting and/or paying taxes there. If you’re not familiar with nexus, you’re not alone. The topic can be tricky because there’s no universally shared definition of it and rules regarding it vary dramatically from state to state. Also, states tend to regularly change their rules around nexus, putting the onus on business owners to research and stay on top of any changes.
Generally, a business is considered to have nexus with another state if:
- It has a store, office, warehouse, or other physical presence there.
- It has no physical presence in the state but has a certain level of economic activity or income there.
- It has employees working there.
If your business does have nexus with one or more states other than where it’s based, you’ll need to register for payroll there and more than likely also apply for foreign qualification. Foreign qualification, if you’re not familiar, is the process of applying to do business in a state other than the one in which your company is registered. To foreign qualify in another state, you must register your company with the Office of the Secretary of State, or a comparable agency, there. Foreign qualifying enables you to operate in another state without having to form and register a new business entity.
If you’d like to learn more about nexus, here are a few additional articles to review:
- A State-by-State Guide to Economic Nexus
- When Do You Have Nexus in a State?
- Virtual Companies and Nexus: What Small Businesses Need to Know
5. Determine If You’re Hiring an Employee or a Contractor
Determining if you are hiring an employee or an independent contractor is important for tax considerations. Normally, an employer withholds and deposits income taxes, Social Security taxes, and Medicare taxes from an employee’s pay and pays the matching employer’s portion of Social Security and Medicare taxes. An employer also must pay federal and state unemployment tax on employees’ wages. Employers do not generally withhold or pay taxes on pay for independent contractors.
I’ve written an article on this subject at Independent Contractor vs. Employee, which will help you ascertain how to classify your new hire.
6. Schedule Your Pay Periods
You can pay employees weekly, biweekly, semi-monthly, or monthly. While biweekly is the most common payment, what you decide will depend on your business’s cash flow and other factors. States have rules about minimum pay frequency for employees, so check with your state’s Department of Labor to see if they apply to you.
Payroll processing can be a little overwhelming for new business owners. We’ve written a lot about this topic, so here are some good articles to review to learn more about the process:
7. Select a Payroll System and Payroll Manager
You can hire a payroll service company to run your payroll or do it yourself using payroll software. You can subscribe to SaaS-based payroll software that lets you automate payroll entries, file necessary tax forms, and perform other steps to remain in compliance with federal and state laws. Before deciding to run payroll in-house, consider your time and the potential for rapid growth of the company that could complicate matters.
Popular payroll processing companies include Gusto, Paychex, and Onpay. These services start as low as $16 per month and scale up based on the number of employees and payroll runs.
8. Create a Formal Policy for Holiday, Vacation, and Leave
You’ll want to make it clear what compensation employees are entitled to concerning pay for holidays, vacation, and family and medical leave. Currently, there are no federal laws requiring this type of compensation, although many states and municipalities have enacted laws. You’ll need to confirm what you’re legally required to do, as well as consider the right compensation mix that will enable you to attract and retain qualified employees.
9. Comply With All Form and Identification Requirements
All new employees must fill out and return a W-4 form, which, as you read earlier, will provide information you’ll need to figure out how much federal income tax to deduct and withhold from their pay. Employees also must complete an I-9 form, which verifies they are eligible to work in the United States. You’ll also need to collect information and report new employees to your state within 20 days of hiring. Information needed includes full names, contact information, and Social Security number, which is put into the National Directory of New Hires and used to locate and withhold wages from people who owe child support. You’ll also need to verify the employee’s name and Social Security number, which you can do on the Social Security Administration’s website.
10. Know What You Can and Cannot Ask Employees
It’s important for everyone who will be interviewing an employee to know how to handle that meeting and what questions to ask or not ask. While it’s fine to ask about prior work experience and what qualifies an interviewee for the job, the Equal Employment Opportunity Commission recommends that you avoid asking about personal characteristics that are protected by law, including race, color, religion, sex, national origin, and age.
11. Consider Optional Employee Benefits
Benefits like group health plans and retirement plans are popular with employees and given a choice between a comparable company that offers them and one that doesn’t, most employees probably would opt for the former. Understanding that it may not be possible to offer optional benefits when you’re just getting the company started, it’s something to keep in mind as your business grows.
12. Consider Employee Incentive Programs
Employee incentive programs such as stock options, flex time, company events, wellness programs, corporate memberships, and others can boost morale and make hiring easier should your need for employees increase. You can decide what kinds of incentives make sense for you based on your budget and other considerations.
13. Create an Employee Handbook
Every company, even a small one, has its own culture. New employees should have a good idea of the company culture and what is expected of them. A well-thought-out employee handbook can go a long way in distributing that information and putting everyone on the same page regarding rules, legal rights of employees, policies, and processes.
14. Adhere to Federal and State Employee Notice Requirements
Employers with annual sales of above $500,000 and those who have federal contracts are subject to the Fair Labor Standards Act (FLSA), which is a federal law that protects workers against some unfair pay practices. It sets minimum wages, requirements for overtime pay, and restrictions on child labor. If the FLSA applies to your company, you may be required to display a poster stating the rules it covers. Some states also have poster requirements, so check with your state Department of Labor to see if any apply to you.
15. Comply With OSHA Rules
If you employ workers, you must comply with the rules of the federal Occupational Safety and Health Administration. These could compel your company to protect workers from harmful substances like asbestos, prevent infectious diseases in the workplace, provide safety equipment, or provide training for jobs considered dangerous. If you’re subject to any of those rules you’ll need to have signs, labels, and codes to warn workers of potential dangers.
As you can see, there’s a lot to consider when hiring an employee! Pay particular attention to payroll taxes, focusing on which taxes you’re responsible for, when they must be paid, how much you’re deducting from an employee’s wages, and other factors. Think long-term when hiring employees, working to build a strong team that will help your company grow and prosper. And remember, if you’re uncertain about regulations that apply to hiring, it’s a good idea to check with an attorney or tax advisor to make sure you’re in compliance.
