Hiring your first employee: the money side

The difference matters because employers withhold and pay payroll taxes for employees, but not for independent contractors. The IRS looks at the whole relationship, including how much control you have over how and when the work is done, how the worker is paid and whether they offer services to others. Calling someone a contractor does not make them one.

If a worker is a contractor, you may need to report what you pay them on Form 1099-NEC (opens in a new tab). If the relationship looks like employment, payroll rules apply. Misclassification can lead to back taxes, penalties and wage claims, so if you are unsure, a tax professional or employment attorney can help.

The SBA’s hire and manage employees (opens in a new tab) guide lays out the process. In general:

1. Get an EIN if you do not have one; it is free from the IRS (opens in a new tab).
2. Register with your state for payroll tax withholding and unemployment insurance, where required.
3. Set up workers’ compensation insurance, which most states require once you have employees.
4. Have the employee complete Form W-4 for federal withholding, plus any state form.
5. Complete Form I-9 to verify identity and eligibility to work, and keep it on file.
6. Report the new hire to your state’s new hire registry.
7. Choose how you will run payroll and keep payroll records.
8. Display the required federal and state workplace posters.

The IRS’s employment taxes (opens in a new tab) page describes the core federal duties: withholding federal income tax from wages, withholding the employee’s share of Social Security and Medicare and paying the employer’s matching share, paying federal unemployment tax, depositing these taxes on the schedule the IRS assigns and filing the related returns, plus year-end Forms W-2. States add their own withholding and unemployment taxes. The IRS and your state publish the current rates and wage bases.

Before hiring, many owners add up the fully loaded cost, not just the wage:

• Gross wages, including any overtime.
• Employer payroll taxes: the employer share of Social Security and Medicare, plus federal and state unemployment taxes.
• Workers’ compensation insurance.
• Benefits you choose to offer, such as health coverage, retirement contributions or paid time off.
• Payroll software or service costs.
• Equipment, training and time spent recruiting and onboarding.

Then check your cash flow forecast: payroll usually comes due before the new hire’s work turns into revenue.

Owners commonly use payroll software, a full-service payroll provider, or an accountant. Points to compare:

• Whether it calculates, deposits and files federal and state payroll taxes for you, or only calculates them.
• Direct deposit and pay stubs.
• Year-end W-2 and 1099 preparation.
• Connection to your bookkeeping software.
• Support for workers’ comp payments, benefits and multiple states, if needed.
• Cost per employee or per pay run, and what happens if the provider makes an error.

Some businesses also look at payroll financing to bridge gaps between paying staff and getting paid by customers. It is a cost, and it does not replace planning.

• Treating workers as contractors to avoid payroll taxes.
• Missed or late payroll tax deposits.
• Paying people in cash with no records.

A tax professional or employment attorney can apply these rules to your business, and SBA resource partners (opens in a new tab) offer free counseling on hiring.