If you started your business solo, at some point you may be ready to hire an employee to help you grow and expand. This can be a daunting task. Below are some steps you can take to properly hire your first and subsequent employees.
Before you begin, make sure you have an EIN number. An EIN is how the IRS identifies you as an employer. You may already have an EIN, as you do not need employees to have one. But if not, get one now.
Do not pay anyone to get an EIN for you. An EIN is easily obtained directly from the IRS and it's free: Apply for an Employer Identification Number (EIN) Online.
Employee vs. independent contractor
When hiring it's important to properly classify your workers as either a W2 employee or independent contractor. State and federal governments both have an interest in ensuring workers who are treated as employees are paid as employees. If you are unsure of this decisions, see the blog post: Employee or Independent Contractor: Factors and Decisions. The remainder of this post discusses hiring an employee.
Hiring process and offer letter
Before selecting an employee, consider checking references and possibly running a background check if your employee will have significant responsibilities or access to sensitive information. Once you receive the background check results and you have questions, discuss with your potential candidate. A person may have made mistakes earlier life and still be an excellent candidate today.
Once you have made an employee selection, it's time to put the offer in writing. An offer letter includes job title, description, who the employee will report to, start date, summary of duties, pay amount, pay frequency, benefit information, if the employment is "at-will," whether the employment is contingent on the results of a background check and a place to sign to accept the offer.
Consider obtaining a job application from each candidate. A job application collects the same education, employment and contact information from each candidate.
An offer letter is not a contract. Once your employee has accepted their offer, consider having them sign an employment agreement which is a contract between you and the employee.
An employment agreement details the rights and responsibility of both the employer and employee, which both must live up to during the period of employment. It covers the employee pay, expectations, duties and benefits in more detail than the offer letter. Work with an attorney to establish an employment agreement that takes into account your states legal requirements as well as the needs of your business.
Consider including an employment probationary, introductory or initial evaluation period. This period can be from 30 days to a year, but is often 60 or 90 days. This time frame allows you to evaluate whether the employee is a good fit for the position. Consult with an employment attorney if this option is a valuable option for your business.
New employees need to complete two federal employment forms. The W-4 form is to withhold taxes from the employee's paycheck and an I-9 form establishes the employees right to work.
If it has been a while since you were employed, you might notice the W-4 looks different. It has been redesigned. See the IRS FAQ on the new form here: FAQs on the 2020 Form W-4. Here are links to the W-4 and I-9 forms:
Do some research to see if your state requires any additional employee forms. For example, in NY employers need to submit an IT-2104 Employee's Witholding Allowance Certificate. In CA all non-exempt employees are required to be issued a Wage Notice.
Choose a payroll processor
It is a good idea to use a service to process payroll for your employee. Payroll rules change frequently and it is a tedious and difficult task to do on your own.
If you use a small independent accountant for payroll, inquire to learn how they oversee payroll and their plan if the office closes or key employees cannot work due to illness, technology problems or natural disaster. Larger payroll services are less likely to close their doors or fail to process payroll due to illness or life changes of the employees.
Once funds are withheld from an employee paycheck, they belong to the government. The government considers non-payment of payroll withholding a serious offense. There are heavy penalties for not paying when due. You want to be confident the money is going to be paid into the system on time.
Popular national payroll processing firms that cater to small businesses are:
If you would like to try Gusto, you can use this referral link to get a discount:
Ask your employee if they would like their check to be direct deposited to their bank. Some states prohibit requiring direct deposit. Around 7% of US workers do not have a bank account and they may have a right to receive a paper check. You are within your rights to require all payments be via paper check, if you do not want to offer direct deposit. Example direct deposit form: Direct Deposit Sign-Up Form.
State unemployment and other state laws
Register with your state unemployment office and workers compensation agency. The payroll processor you choose may help with how to do this. When hiring an employee, do research and consult with an employment attorney to be sure you are aware of any state employment laws.
Your employee will need an email address and may need to be set up on your phone system and/or business webpage. Consider ordering business cards for your new employee. Evaluate your technology needs for this employee and have this read to go on day one of employment.
Keep a list of steps you take to set the employee up on your systems so you have it available when it's time to hire a second employee. This list will be useful when your employee leaves, so you can reverse the steps at the time of termination.
Make a call to your insurance company to review your business insurance needs now that you have an employee. You may need to add to your insurance coverage.
There may be a time when you wish to reimburse your employee for mileage, travel, training costs or maintaining a home office at your request. To do so, you need an accountable plan.
An accountable plan is a policy that determines under what conditions the employee can be reimbursed. Having an accountable plan ensures reimbursements made to the employee are not taxed to the employee as income. If you do not have an accountable plan, any reimbursements must be included as wages and are taxable as income to the employee.
Speak with your tax professional about establishing an accountable plan. If you do not have a tax professional, see the Simple Profit blog, Interview a Tax Preparer: Questions to Ask.
Employee benefits can include paid time off, health insurance and retirement savings opportunities, among other benefits. As a small business you may not be able to afford benefits initially. As you grow you may plan to offer employee benefits. Ensure that you can afford employee benefits before you make a promise to offer benefits.
If you are unsure if you can afford to offer benefits, determine the cost of the benefits you wish to offer and save the cost equivalent to the benefits each month for six months as if you were already committed to them. This will accomplish two goals: 1) you will adjust your cash flow to accommodate the cost and 2) you will have saved a cash cushion for future months if cash flow decreases.
Below are some resources to aid small businesses in offering retirement and health insurance benefits to employees:
It is required that you maintain as well as safeguard all employee records. Employee records will contain sensitive information such as the employees social security number. Employee records include:
Hard copy employee records should be locked and kept where they cannot be easily accessed. Do not lock records in a file cabinet and hang the key nearby.
It is more common to keep records electronically. Gusto allows all your employee documents to be signed and stored electronically. Patriot Payroll has an HR service for an additional monthly fee. You can also use a service like BambooHR to manage and store all employee records.
Various employee records are required to be maintained for 1, 3, 6 or 7 years. When in doubt, maintain all employee records for 7 years. Before getting rid of employee records, confirm with an attorney that you are safe doing so.
Plan to review your employees performance soon after they are hired and at least annually thereafter. Performance evaluations include:
Evaluations can be stressful, but they are very important. Approach these meetings with professionalism, a mindset toward improvement and a focus on the big picture.
Hiring a child or relative
Your first employee may be a relative or your own child. If so, you may be able to avoid paying federal unemployment tax for certain relatives, or avoid social security and medicare tax if a minor child if you are self-employed as a sole proprietor or LLC business. Corporation owners and their children cannot get the same savings of payroll taxes, however, there are still benefits to hiring your children.
Hiring a child can help reduce overall taxes because your child will usually have a much lower tax rate than you. Any family member including a child, must a real job that is appropriate for their age, skill and ability, and a reasonable wage. It is not appropriate to pay an 8 year old $100 per hour to monitor your social media. But an 8 year old could do light cleaning for a short period of time per week at a wage fitting for their age.
The federal government allows children to work in a business solely owned or operated by their parents, with a few limitations. See Exemptions to the FLSA for minors under the age of 16 for more details. Your state may also have exceptions for minors working for parents, make sure to check before you hire your child.
Keep records of hours worked and the work being performed as you would any other employee. If audited, you will need to show the child actually did work for you. These IRS resources can help understand the rules for employing a family member:
Note A: It is very unlikely a child or close relative working for you would be an independent contractor unless they are truly operating their own separate business. Most often they will need to be hired as an employee. The same working misclassification rules apply for relatives, however, it's more likely there is control when the worker is a relative and especially if the worker is your own child. See Employee or Independent Contractor: Factors and Decisions for more details.
Note B: Because Corporation owners don't get the same benefits as self-employed owners to avoid payroll tax when hiring the owners children, some tax professionals advise forming a Family Management Company as a self-employed business and have the children paid from that business. This plan averts the intent of the IRS to prevent Corporation owners from getting the payroll tax savings and the Family Management Company lacks its own profit motive therefore is not a legitimate option.
Solo business to team adjustment
If you have been operating as a solo business owner, expect there to be some adjustment to having an employee and working as a team. A new level of cooperation and communication will be needed. It may be difficult to give up on some tasks and let go of control. Focus on open communication, clear expectations, a commitment to professionalism, kindness and employee development to create a smooth adjustment over time.
Growing and requirements
The larger your employee workforce the more requirements you want to be aware of. Companies with 50 or more employees may be required to offer health insurance and companies with 100 or more employees may be required to fill out the EEO-1 Employee Survey. The larger your workforce the more you will want to be consulting with an employment attorney to ensure compliance with state and federal laws.
As you grow, consider creating an employee handbook. An employee handbook details rules and policies for your office, employee expectations and employer/employee responsibilities. It can also detail where employees can turn for help if they have a problem. It is a document that communicates consistent information to all employees, so you do not have to worry that you've told one employee and not another. It can define your business mission and vision and highlight employee benefits.
See this Employee Handbooks: A Complete Guide from Complete Payroll.
Hiring an employee for the first time may be stressful and involve a daunting amount of paperwork. With the proper mindset, time and resources this can be an important step in growing your business. Take this process one step at a time and soon you will be a pro at onboarding employee and be set to grow your business.
Questions: email [email protected]
Jennie Schottmiller, LMFT, CPA is a licensed marriage and family therapist who practiced as a CPA prior to becoming a therapist. She has an active solo therapy practice and offers courses to help small business owners with accounting, tax and financial analysis matters.
Disclaimer: This blog is for education only. Please consult with a qualified professional when you have any questions about your personal accounting, tax or legal situation. Information contained in this post is for informational purposes only and not intended to replace professional advice.