Congratulations on establishing your small business to the point that you are ready to hire some help.
We know it takes a lot to run a small business so to help you with this important milestone, we have put together resources to help you avoid common pitfalls when it comes to hiring and paying employees and independent contractors. In our Small Business Guide, we will cover everything from the different types of hires to reporting and compliance.
Understanding different types of hires
Employee vs. independent contractors
As your business grows and you find yourself ready to hire staff, there are determinations to make about the type of hire you want to bring onboard. There are two types of hires, a full-time employee and an independent contractor. It is important to understand the differences between the two and decide what is best for your business in advance of hiring because this classification will impact how you manage, pay, and file taxes for the worker.
Employee — The work of an employee is defined by the IRS as being directed and controlled by you, the employer. A traditional 9 to 5 employee that receives specific direction on how and when to complete work will likely fall under the employee classification.
Independent contractor — On the other hand, the work of an independent contractor is not directed by the employer. Rather, the results of the work are directed by the employer. This means independent contractors do not receive explicit instructions on what will be done and how it will be done, only the end result.
These two classifications can be tricky, and it is important to get it right, otherwise, you could find yourself paying penalties or fees. If you still aren't sure whether you are hiring an independent contractor or an employee, check out the IRS's regulations first.
The rest of this article applies only to employees. If you have determined that you are hiring an independent contractor, check out our article on how to pay an independent contractor.
Is my employee exempt or non-exempt?
The second determination to make is the exemption status of your employee. This decision only applies to employees, not to independent contractors. Employee exemption status is governed by laws under the Fair Labor Standards Act or FLSA. Under the FLSA, employees are either exempt or non-exempt. You may also hear these people refer to these as salary and hourly employees.
To determine the exemption status, you can utilize tests provided by The Department of Labor. These tests include the salary level test, the salary base test, and the duties test. These three exemption tests measure an employee's duties, span of independent judgment over their work, and salary.
So, what does it mean if your employee is non-exempt? Non-exempt employees are protected by FLSA laws and must be paid at least the minimum wage for every hour of work. They also must be paid overtime pay for any hours worked over 40 per week at a rate no less than one and a half times their regular pay rate. Exempt employees must earn more than the salary threshold and pass the duties test. Exempt employees are not required to be paid for overtime.
Taking the time to evaluate the exemption status of your employees is worthwhile, getting it wrong can end up being a costly mistake.
New hire paperwork
Now that you are ready to bring your new employee onboard there are forms that must be collected and filed by the employer. These forms include:
Form W4 — A signed W4 is required from each employee. This form tells the employer how much federal income tax to withhold from their pay. Employees can change their W4 elections by submitting an updated Form W4. The PaycheckCity W4 Calculator can be used by employees to complete and print their W4.
Form I9 — The Form I9 is supplied by the Department of Homeland Security and is used to document the eligibility of your employee to work in the United States. To first step in completing the Form I9 is for your employee to complete the I9 and provide you with approved identity and work eligibility documentation to you for verification. The Form I9 is then retained by the employer. It is not necessary to submit the Form I9, rather just to maintain in your files should you need to produce it in the future.
State new hire report — As an employer you are required to report new hires and rehires to your state within twenty days of hire, and some states require it sooner. All businesses in the United States are required to report new hires, regardless of business size, industry, or sector. New hire reporting is used by states to determine if an employee owes money for child support and to prevent certain types of fraud.
Pay frequency or a payroll schedule refers to how frequently you pay your employees. When deciding on pay frequency it is important to understand the legal requirements as well as the practical implications. Each state has its own laws governing pay frequency. These laws range from a specific frequency to industry specific requirements. The four most common pay frequency options are:
There is no one-size-fits-all approach to pay frequency. As long as the pay frequency you select is compliant with state law, the determination should be based on the needs of your business and employees. For some industries, like the service industry, it is typical to pay more frequently and in larger businesses it is common to pay on a bi-weekly or semi-monthly schedule.
As a business owner who pays employees, you are responsible for paying employer taxes and withholding employee payroll taxes. The taxes that you withhold from your employee's paycheck are due to the respective taxing agencies at certain times of the year in addition to the taxes you owe as an employer.
As an employer, you are responsible for paying the following taxes:
- — the Federal Unemployment Tax Act or FUTA created a tax that covers compensation for workers who have lost their job.
- — this tax is made up of Social Security tax and Medicare tax. Both employers and employees pay FICA taxes.
State and local tax — states, counties, and municipalities can have additional taxes that employers are required to pay.
As an employer you are responsible for withholding the following taxes from your employees' paychecks:
Federal — federal income tax is an employee only tax. There are seven federal tax rates that increase as an employee's federal income increases. The amount of withholding is determined by the employee's Form W4.
FICA — this is the employee portion of Social Security tax and Medicare tax.
State and local tax — There may be additional state and local taxes that an employee must pay. Local taxes can include city, county, or municipalities.
It can be difficult to keep track of all of these taxes, so use the PaycheckCity calculators or PaycheckCity Payroll to determine precisely what taxes apply to your employees' paychecks.
Reporting and compliance
Form 940 and 941
After withholding payroll taxes from employees' paychecks, you need to report and remit them. Payments are typically due on a quarterly and annual basis but can vary depending on the size of your company. Below are the federal forms that are used to report and remit this information:
- — reports federal Income Tax, Social Security, and Medicare tax, filed and paid quarterly.
- — reports Federal Unemployment Tax (FUTA), filed and paid annually.
- — reports federal income tax, Social Security, and Medicare tax for small businesses whose annual payroll tax liability is $1,000 or less per year. This annual form is utilized in place of the quarterly Form 941. If you pay someone to do household work and that worker is your employee, you may be a household employer. Check out the IRS's Publication 926, Household Employer's Tax Guide for guidance on withholding and filing household employment taxes.
Employee wages are reported through the Form W2 on an annual basis. The W2 provides a record of the employee's earnings, deductions, and withholdings and is required for all employees who earn more than $600 in one year. It is the employer's responsibility to furnish and distribute W2s to employees and file the W2s with the Social Security Administration (SSA) by January 31st of the following year.
Employers with less than 250 employees have the option to file their W2s with the SSA through the mail using paper copies or electronically through the SSA's Business Services Online. Employers with more than 250 employees are required to electronically file W2s.
The W2 has six copies:
Copy A — is sent to the Social Security Administration and must be printed on official paper provided by the SSA
Copy B — is provided to the employee for filing their federal tax return
Copy C — is provided to the employee for their personal records
Copy D — is kept for the employer's records
Copy 1 — is for the employer's state and local tax return
Copy 2 — an additional copy for employer state and local tax returns if needed
Small business payroll
Hiring and paying your first employee and every employee after that is an exciting, but often daunting, prospect when it comes to all of the tax information to keep track of. PaycheckCity has resources to help make sure all of your bases are covered. To avoid penalties and be payroll compliant you can use our small business checklist.
If you are looking for a small business payroll provider, PaycheckCity Payroll by PaycheckCity is right-sized and right-priced for your small business. Learn more here.
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These free resources should not be taken as tax or legal advice. Content provided is intended as general information. Tax regulations and laws change and the impact of laws can vary. Consult a tax advisor, CPA or lawyer for guidance on your specific situation.