One of the benefits of being a sole proprietor is having complete control over your firm. Sole proprietorships are also one of the easiest businesses to establish. But there’s a good chance you’ve worked more than one 15-hour day to meet deadlines and satisfy clients. With your business expanding, you may require additional assistance—hiring an employee appears to be the logical next step. But the question is, can you, as a sole proprietor, recruit employees to help out? The short answer is that you most certainly can. But there’s a catch: as a sole proprietor, you must obey all applicable labor and tax rules when hiring personnel.
The ensuing paragraphs cover the rules that involve hiring employees as a sole proprietor and other basic information around this subject.
Let’s jump right in…
What is Sole Proprietorship?
It’s helpful to first understand the company model before attempting to answer the question “can a sole proprietor have employees?” A sole proprietorship is an unincorporated business that is owned and run by one person, making it one of the most straightforward company structures. The IRS considers the owner and the organization to be one and the same. This means that a sole proprietor is accountable for all of the business’s debts, losses, and liabilities in addition to receiving all of the profits.
Can a Sole Proprietor Have Employees?
For many firms, a sole proprietorship is the first stage. It’s a form of company entity that allows you to open a business and begin your self-employment path without having to go through legal hurdles. It’s a business that isn’t incorporated and usually has only one proprietor. Spouses, on the other hand, can own a business together.
However, being a sole proprietor does not imply that you must run your company alone. As a sole proprietor, you have the option of hiring personnel. In fact, whether you’re employing your first employee in Georgia or Oregon, there’s no limit to how many people you can hire.
Just keep in mind that you’ll be responsible for protecting yourself and your company, as well as tax filings and good management of those you recruit, including:
- Following state and municipal licensing and permit regulations
- Obtaining an Internal Revenue Service (IRS) Employer Identification Number (EIN) (you may also need an EIN to open a bank account or credit card)
- Verifying employment eligibility in the United States
- Obtaining each employee’s name and Social Security number
- Obtaining information on income tax withholding
- Purchasing workers’ compensation insurance and other small company insurance requirements
If you’re recruiting your first employee in Texas, for example, you’ll need to comply with all local, state, and federal regulations. You’ll also need a system to maintain track of bookkeeping records such as payroll taxes, federal and state employee income taxes, and self-employment taxes.
What About Independent Contractors?
Independent contractors and sole owners have a lot in common. A sole proprietor normally creates things, teaches lessons, sells products, or performs a service, whereas an independent contractor frequently works for someone else (but not as an employee).
You don’t need to set up a legal corporate structure to work as an independent contractor. Simply starting your own business and delivering services to others (consulting, web design, or construction) without being an employee qualifies you as an independent contractor.
So, can a sole proprietor hire employees? Yes! You are your own business as a sole proprietor, and businesses are able to hire people.
However, just like if you were a sole proprietor, you’ll need to take precautions to safeguard and prepare yourself and your firm.
Hiring a Spouse
The sole proprietor does not have to pay federal unemployment tax (FUTA) on their spouse’s salary if they are a bona fide employee and not a company partner. However, federal income tax and federal insurance contribution act (FICA) taxes still apply to spouses.
Depending on the age of the child, sole proprietors who hire their children withhold taxes in different ways. The following are some basic guidelines:
- FICA taxes do not apply to children under the age of eighteen.
- FUTA taxes do not apply to children under the age of 21.
- The federal income tax applies to all children, regardless of their age.
What to Do Before You Hire Employees as a Sole Proprietor
The following are a few things that must be in place before you start hiring as a sole proprietor.
Obtain an EIN
You must request and obtain an employer identification number before hiring staff. This is the number that appears on your tax returns and other tax papers. To obtain an EIN, you must complete IRS Form SS-4.
Think About Changing Your Company’s Structure
You can legally continue to operate as a sole proprietor while employing people. However, doing so might put you in serious legal trouble. If you operate as a single proprietor, your personal assets may be at danger if you have legal troubles with employees down the line. Choosing a different business entity can provide you with additional protection and allow you to access more resources accessible to corporation owners.
Register With the Department of Labor in Your State
The Florida Department of Economic Opportunity can help you register your business. After you’ve completed this procedure, you’ll be able to pay state unemployment compensation taxes.
Investigate Your Insurance Options
Before you hire someone, be sure you have workers’ compensation insurance. If an employee is injured on the job, you could be responsible for their medical bills and lost pay.
In Florida, you don’t have to get workers’ compensation insurance until you have four employees. Purchasing insurance straight away, on the other hand, can safeguard your company from litigation and help it grow.
Set Up Your Payroll and Tax Withdrawals
You must withhold taxes from your employees’ paychecks and send them to the IRS as an employer. In addition, Medicare and Social Security taxes must be paid. An automated payroll system can save you money in the long run by preventing costly mistakes and fines at tax time.
Prepare Employment Forms
Hiring employees necessitates a significant amount of documentation. You must complete IRS Form 940 each year and pay federal unemployment tax. It’s also possible that you’ll be compelled to post notices and posters on your employees’ rights and protections. You must complete Form I-9 for the USCIS and Form W-4 for the IRS for each new hire.
How To Hire Employees When You’re a Sole Proprietor
You are not limited in the number of workers or independent contractors you can hire as a business owner. When you hire someone, though, you must follow a few more steps in terms of taxes and documentation.
Here are some of the processes that must be taken while employing personnel.
Step 1: Obtain an EIN from the Internal Revenue Service
You must get an Employer Identification Number (EIN) from the IRS if you are a sole proprietor and want to hire personnel.
Basically, if you don’t have staff, your social security number (SSN) serves as the business identity for tax purposes.
Step 2: Submit Job Application Forms
You must receive an IRS Form W-4 from each person you recruit. This form tells you, as the employer, how much to withhold for federal taxes from their paycheck.
W-4 tax forms are only required from workers who receive paychecks, not invoices from independent contractors.
Instead, ensure that independent contractors provide you with IRS Form W-9. You will receive their taxpayer identification number (TIN) on the W-9 form, which you will use to report the money you paid them.
Step 3: Determine the Advantages
You must include some employee benefits in your compensation plan in addition to selecting how much to pay your W-2 employees.
Federal or state legislation mandates the following benefits:
- Taxes on Social Security
- Taxes on Medicare
- Insurance for workers’ compensation
- If you live in California, Hawaii, New York, New Jersey, Rhode Island, or Puerto Rico, you must have disability insurance.
- The Family Medical and Leave Act (FMLA)
- Unemployment benefits
Meanwhile, some states mandate that firms provide retirement plans to their employees. State-sponsored retirement programs exist in California, Connecticut, Illinois, Massachusetts, Oregon, and Washington, while many other states have approved similar legislation that has yet to be implemented.
Benefits are only required for W-2 workers, not independent contractors. The term “employee” is defined differently in each state. Check your state’s website for employment definitions and requirements for the most up-to-date information for your company.
In addition to the mandatory perks, you can provide additional incentives to your employees. Health insurance, private retirement plans, longer leave, and pre-tax transportation are just a few examples.
Step 4: Set Up Your Payroll System
You’ll need to set up a pay system once you’ve decided on employee salaries and pay periods. You can use manual tools such as paper timesheets and checks, but this might be inconvenient.
Payroll software companies make it simple to process payroll and manage workers’ compensation insurance for all types of employees, including part-timers.
Step 5: Withhold Taxes from Payroll
You’re responsible for withholding federal income taxes each time you pay an employee, whether you do it manually or via software. You must specifically withhold FICA taxes, which include Medicare and Social Security. To compute federal taxes, you can use the IRS Tax Withholding Assistant or a payroll software solution that does it for you automatically.
However, if you wish to offer optional benefits like private health insurance or retirement programs, you’ll need to set up payroll deductions.
Meanwhile, employees must pay their part of Social Security and Medicare taxes, which are withheld from their paychecks. Workers’ compensation insurance is also paid for by employers.
Furthermore, employers normally pay unemployment and disability insurance, though this is not the case in every state. Employees, not employers, are taxed in California for disability insurance. Check the website of your state’s department of labor to determine your state taxes.
Employers must only provide 12 weeks of unpaid, job-protected leave each year for events such as the birth of a child, adoption, or the death of a family member, according to the FMLA. There is no payroll deduction because FMLA does not demand paid leave.
Step 6: Maintain Employee Records
When you hire staff, you must adhere to certain government-mandated recordkeeping obligations.
Keep in mind, in particular:
- All personnel and employment records in the past one year
- All payroll records in the past three years.
While the plan is in effect and for one year after it is terminated, it can be used to fund pension, insurance, and other benefit plans.
Any written seniority or merit plan while it is in effect and for one year after it ends
Again, employing software to manage your payroll and taxes can make it easier to keep track of data and adhere to federal regulations.
Can a Sole Proprietor Have Employees? Filing Taxes for Employees and Independent Contractors
Because a sole proprietorship lacks a separate business entity, you must file business taxes on your personal income tax returns.
Instead of a W-2, you record your business revenue on IRS Form Schedule C (Profit or Loss from Business).
You’ll need an EIN if you have W-2 employees. Otherwise, the taxpayer identification number for your business is simply your social security number.
Furthermore, you have additional bookkeeping obligations and must file additional forms with your income taxes after you hire a W-2 employee or independent contractor to work for your firm, which we’ll explore next.
Tax Forms Required With W-2 Employees
Here are the forms you’ll need to submit along with your tax return:
- FICA taxes withheld from employee paychecks are reported on IRS Form 941, which must be filed periodically.
- Annually, file IRS Form 940 to report FUTA (Federal Unemployment Taxes) withheld.
- Form for filing a state unemployment tax (filed annually; these forms vary by state)
- Annually, file IRS Form W-3 to record total wages paid to all employees.
You must also provide your employees with the following forms:
- Distribute IRS Form W-2 to employees by January 31. Provides them with information on wages earned and FICA taxes withheld.
- Each W-2 employee you recruit must fill out an IRS Form W-4, which tells you how much tax they want withheld from their paycheck.
Using Independent Contractors to File Taxes
Independent contractors, unlike employees, are not paid on a regular basis and are liable for their own self-employment taxes, which include Social Security and Medicare taxes.
Even so, if you pay an independent contractor more than $600 in a fiscal year, you must send them an IRS Form 1099-NEC, which shows the entire amount you paid them. By January 31, they, like W-2 forms, should be given to contractors and the IRS. You’ll have to pay a penalty for each late file if you miss the deadline.
You should always request an independent contractor’s taxpayer identification number using IRS Form W-9 whenever you hire them. You’ll need this information to fill out the 1099-NEC form.
What Methods Do Sole Proprietors Use to Pay Their Employees?
Employees of sole proprietorships are paid similarly to those of larger enterprises, but on a smaller scale. The basic steps are as follows:
#1. Work Out Your Gross Compensation
Employers multiply the total hours worked by the hourly wage for non-exempt hourly workers. If any overtime is performed, the employer must increase the number of overtime hours by the applicable overtime rate and add the result to the base salary. Employers divide the annual salary of exempt employees who are paid on a salary by the number of pay periods.
#2. Pre-tax Deductions Should Be Withheld
Employee contributions to health care or retirement savings plans that are funded on a pretax basis are deducted by the employer.
#3. Refrain from making statutory deductions
Employers must withhold federal income tax, FICA tax, and any other state or local taxes that apply.
#4. Post-tax deductions should be withheld.
Some sorts of voluntary benefits and wage garnishments, if necessary, are eligible for post-tax deductions.
#5. Compensate Employees
Employers can pay employees via direct deposit into their bank accounts or via another electronic means, such as paycards, depending on state regulations. In all areas, traditional paychecks are also permitted.
Can a Sole Proprietor Have Employees: What Types of Employee Forms Do You Need?
In addition to the previously mentioned Form W-4 and Form I-9, sole proprietors may require any of the following documentation from their employees:
- Job application completed and offer letter signed
- A W-4 form; if state withholding certificates differ from federal withholding certificates
- Information about your bank account for direct deposit
- Employee handbook or corporate policy signed acknowledgment
- Forms for authorization to participate in health-care or retirement-savings programs.
Meanwhile, the papers needed will vary depending on the type of business and the state of employment.
When Should a Single Proprietorship Be Upgraded to a Corporation?
The decision to restructure a sole proprietorship is unique to each situation and should be discussed with an experienced attorney and/or tax specialist. On the one hand, sole proprietors avoid double taxation and pay lesser taxes than other business kinds. On the other hand, there is no distinction between personal and commercial assets, meaning that property, vehicles, savings accounts, and other assets could be at risk in the event of a lawsuit or claim.
Changing Organizational Structure
The formation of a limited liability company (LLC) from a sole proprietorship gives liability protection against the activities of workers. Pass-through taxes and financial credibility with lenders are also advantages. The following are the general procedures to take if business owners determine that this structure is the best option for them:
- Pick a unique name that isn’t already in use.
- Articles of incorporation must be filed with the state.
- Procedures for operation should be written down.
- Pay the state the required fees.
- Make a public announcement about the LLC
- Sole Proprietorship and Limited Partnership- Choices before you register your firm
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