Congratulations! You have started your business and you are ready to hire your first employee. Where do you begin? What will the employee's schedule be and how much will the employee get paid? Will your new hire be an employee or an independent contractor—and what is the difference? Did the employee sign an employment agreement? Before your new hire begins, there are some basic things you need to know about payroll, taxes, and required state and federal filings.
Here are several concepts to consider as you get started. This is not intended to be a comprehensive article covering all employer and tax rules, so be sure to consult with professionals, such as your business attorney and tax advisor, regarding your specific responsibilities and duties under local, state, and federal laws.
- Categorizing workers. The Fair Labor Standards Act (FLSA) classifies employees as exempt or nonexempt. Exempt employees are excluded from the FLSA's overtime pay provisions, whereas nonexempt employees qualify for overtime pay if they work more than forty hours per week. Generally, salaried employees may be exempt and hourly employees are considered nonexempt. Additionally, it is important to understand the difference between an employee and an independent contractor. An independent contractor is considered self-employed and is responsible for tracking hours worked and paying taxes due. In contrast, an employer is responsible for withholding and paying payroll taxes on behalf of employees. Misclassifying a worker could cause an employer to fail to pay overtime or provide other benefits to an employee who earned them—which could lead to substantial civil penalties.
- Pay period and payday. As an employer, you must decide how often you will pay your employees (pay period) and when they will be paid (payday). The pay period will be the time from the start to the end of the employee's recurring work schedule. Some employers pay employees weekly, and others pay biweekly or monthly. The payday is the date on which you will pay your employees. The payday is usually a set date following the end of a pay period, which impacts when your payroll taxes are due. No matter how you set up your pay period and payday, you must make sure you always pay your employees on time.
- Adhering to federal, state, and local laws. Employers must become familiar with the federal, state, and local labor and employment laws. Some states have a minimum wage that is higher than the federal minimum wage, and the FLSA regulates overtime pay and protections for children that work. While you can obtain information from your state or local employment agency, it is critical to consult with an experienced business lawyer or tax advisor to ensure that you follow your local and state regulations. In addition, utilizing a payroll service is money well spent as this type of provider is well versed in the laws and can assist in setting up and maintaining your payroll records in accordance with the various laws.
- Payroll taxes. As an employer, you are responsible for withholding and paying federal, state, and local taxes from employees' paychecks and paying the taxes you, as the employer, owe on behalf of the business. Generally, employers withhold federal income tax, Social Security, and Medicare tax from employees' paychecks. Form W-4 is a federal tax form that employees complete to let the employer know how much tax to withhold from their paycheck based on filing status, dependents, etc. The employer is responsible for paying a matching amount of the Social Security and Medicare tax, as well as the Federal Unemployment Tax (FUTA). The FUTA is a federal tax that (along with the applicable state unemployment tax) creates a fund for unemployment compensation for eligible employees who have lost their jobs. In addition to withholding and paying these taxes, the taxes collected or withheld from the employees' pay must be reported to the respective federal, state, and local agencies. Along with these federal taxes, the employer may be required to withhold and pay a state or local income tax. Not withholding, paying, or reporting taxes can result in both fines and criminal penalties. Again, a payroll service typically makes this process run more smoothly than trying to handle all of this work on your own.
- Submitting payment for federal, state, and local taxes. Payroll taxes (federal and state) are usually paid on a monthly basis. Unemployment taxes might be due on a quarterly or annual basis, depending on your state's laws. Depending on the size and type of business, the taxing authorities may notify the employer if taxes are due more often. In addition to submitting the tax payments, the employer is responsible for filing certain federal forms, such as Form 941 (the federal tax form due each quarter to report federal withholdings for employees) and Form 940 (which is due annually and reports the FUTA). Depending on your state, additional state returns may need to be filed. Annually, employers must submit Forms W-3 and W-2, which track the wages paid to employees during the year.
- Record-keeping. Employers are required to keep track of hours worked by nonexempt employees and to maintain records (such as employment contracts, time sheets, and tax forms) for both exempt and nonexempt employees. It is a good idea to maintain files for all workers (employees and contractors) and to keep separate files for payroll and taxes. Carefully maintaining these files will help you prepare and file your quarterly and annual tax returns.
- New hire procedures. Now that you understand the basics of payroll, make sure you follow a standard set of procedures for each new hire. At a minimum, every new hire should receive a letter specifying the new hire's status as an employee (or an independent contractor, if applicable) as well as the pay structure and terms of employment. You should also provide the necessary tax forms for the new hire to complete, such as Form W-4, to indicate the new hire's federal tax withholding and applicable deductions. If the new hire is an independent contractor, have him or her complete Form W-9, which requests the new hire's identity and Taxpayer Identification Number. Lastly, each new hire should complete U.S. Citizenship and Immigration Services Form I-9, Employment Eligibility Verification, and you must maintain the signed form and copies of the required identification documentation in the personnel file.
As mentioned above, this is not intended to be a comprehensive article to cover all employer and tax rules. Payroll is more detailed and complicated than simply writing checks to employees. Be sure to consult with professionals, such as your business attorney, tax advisor, and/or payroll service provider, regarding your specific responsibilities and duties as an employer under state and federal laws. Consulting a professional can ensure that you comply with federal, state, and local employment requirements and avoid hefty penalties. If you are making a new hire and are unsure of where to begin, we can refer you to a qualified employment law attorney!