Hired your first employee? Here’s what you need to do next
Hiring an employee means new possibilities but also new tax obligations.
Starting a business can be a lonely venture. You may have started your business on your own - creating flower arrangements in your dining room, soldering circuit boards in your garage, or perfecting recipes in your own kitchen. You're no longer a one-person band when your business expands, and you’re ready to take on your first employee.
Hiring your first employee is a major milestone and a huge moment in every entrepreneurial dream. You can share the burden of day-to-day tasks, off-load work that’s been holding you back from taking your business in new directions, or double your output to generate even more inventory.
Employee or not? Know who you’ve hired
When entrepreneurs and small business owners hire someone to work for them, one of the biggest questions is how to define the person’s status. Specifically, have they hired a contractor or an employee?
Both statuses have advantages and disadvantages, but it’s essential to be sure you know which is true for your situation. When it’s time to file your taxes, the IRS will want to know which scenario applies, and they’ll want you to be accurate, as you can be held liable for any employment taxes you failed to pay for a misclassified worker.
The difference between an independent contractor and an employee may seem subtle. Still, it comes down to the terms of your relationship and the degree of control you have over the person’s work and how they do their job.
If you’ve hired an independent contractor, this person is technically self-employed. You contract them to do a job for your business, but they can complete it on their terms. An independent contractor only owes you the results of their work, not specific hours, processes, or the means of their method.
An independent contractor usually supplies their equipment and is responsible for their expenses. They are generally free to take on other clients, and their services don’t fall under the purview of your business. You won’t withhold taxes for them and will instead send them a 1099 form.
An employee is someone who performs services for your business, and you can control what will be done and how it will be done. You have a say over the details and the process of the task you’re asking the employee to perform, can set specific hours for the job, and aren’t just reviewing results at the end of the project.
For an employee, equipment is typically supplied by the business, expenses are reimbursed, and their compensation may include benefits like paid time off and pension plans. In this scenario, you will complete a W-2 at the end of the year and will have to pay employment taxes.
Knowing the difference between an employee and an independent contractor can get confusing, but the IRS has a resource to break down the topic further if you’d like more insight. This distinction is important, and once you’ve got your first employee, it’s time to be sure you’re keeping compliant with all regulations.
| Hiring your first employee is a major milestone. Just be sure it doesn’t become an obstacle to staying compliant with tax regulations.
Congratulations, it’s an employee! What’s your responsibility?
When you hire an employee, you’re responsible for withholding, depositing, paying, and reporting employment taxes, sometimes called payroll taxes. At the end of each year, you’ll also have to prepare and file a W-2 Wage and Tax Statment, which reports any wages, tips, and other compensation paid to each employee in your business. You’ll submit a copy to the Social Security Administration and your employees so they can accurately report their wages.
The taxes you’re responsible for are broken down into a few different categories, and you’ll want to understand the taxes you’re required to track, report, and pay.
- Federal income tax – The federal income tax, in general, must be withheld from all employee’s wages, and employers use each employee’s Form W-4 to calculate the appropriate method and amount.
- Social security and Medicare taxes – Obligations to pay Medicare and social security taxes are shared by the employee and the employer, so you’ll have to withhold half of the amount from the employee’s wages and then pay your share. Also, if your employee’s compensation exceeds $200,000 within a single year, you’ll have to withhold an extra 0.9%, but you will not have to match this additional amount.
- Federal unemployment tax – As an employer, you’ll pay federal unemployment tax (FUTA), which is separate from federal income tax and social security and medicare tax. Employees do not contribute to this tax, so you won’t withhold any amount for it from their pay.
Depositing and reporting aren’t one-time tasks
The IRS uses Publication 15 to determine what deposit schedule you should follow. Depending upon your business and your past filing history, tax deposit and reporting due dates can vary. The reporting schedule you follow may not be the same as the deposit dates you’ll follow. You’ll want to check with the IRS to determine which schedule is correct for your business.
Reporting due dates
Every employer who makes reportable payments must report these to the IRS, whether they use 1099-NEC to report payments of $600 or more to non-employees or a W-2 to report the wages, tips, and other compensation paid to an employee. Employers must file the required forms by the due date or on the next business day if the date falls on a Saturday, Sunday, or legal holiday.
- Quarterly – Employers reporting every quarter must file a month after the end of each quarter, on April 30, July 31, October 31, and January 31 of the following year.
- Annually – If you report annually, you must file W-2 forms for each employee by January 31. You must also furnish a copy to your employees by this date.
- Federal unemployment tax return – You’ll use Form 940 to report your annual Federal Unemployment Tax Act (FUTA) tax.
Deposit due dates
In addition to estimated tax payments, you’ll be required to deposit the taxes you’ve withheld and your part of any taxes to the IRS.
The IRS requires employers to use the Electronic Federal Tax Payment System to make these deposits. You must meet these deadlines by the required date or the next business day if they fall on a Saturday, Sunday, or legal holiday.
- Monthly – If you’re required to follow a monthly deposit schedule, you’ll have to make employment tax deposits for each month on the 15th day of the following month.
- Semi-weekly – If you follow this schedule, you’ll deposit employment taxes on Wednesdays, semiweekly, for payments made the week prior.
- Next-day deposit rule – There is a caveat. If you ever accumulate $100,000 or more in taxes on any day within either schedule, you’ll have to deposit the tax on the next business day.
- Federal unemployment business tax deposits – As a rule, FUTA taxes are paid quarterly. However, if your FUTA tax liability is $500 or less for a quarter, you should carry that amount over to the next quarter until the amount reaches $500 or more. If the amount is $500 or less at the end of the fourth quarter, you can deposit at the time or pay the tax as part of your Form 940 by the January 31 deadline.
Because your exact schedule may vary depending on your business, you’ll want to keep track of essential reporting deadlines and employment tax deposit due dates. Failing to do so may result in penalties up to 15 percent or $10,000. Make it a priority to stay up-to-date with relevant deadlines to help you and your employees comply with tax regulations.
Start early and stay up-to-date
Hiring your first employee is a huge step, and while it can mean taking on a lot more tax responsibility, it can also mean great possibilities for your business. Set yourself up for success early by understanding your tax obligations and avoiding common pitfalls.
Tools like Complyant have helped companies save over $5.5 million in tax penalties and interest and more than 100,000 hours. With just a little upfront effort, you can be prepared to manage your employment tax and other business tax requirements throughout the year. That means you and your employees can spend a lot more time focused on day-to-day operations, building brand loyalty, and expanding your business.