Hiring Employees - The Basics Rated:

Hiring an employee can be a smart move for a small firm that is growing and expanding its reach. But before you take the step of adding to your workforce, there are a number of considerations to take into account. Fortunately, your financial software can help you at many steps along the way.

Pre-hiring considerations

Independent contractor or salaried employee? The people who work for you can be divided into two types: independent contractors (whose earnings go on tax form 1099) or employees (who use form W-2). This is an important distinction for tax purposes and is closely monitored by the IRS. Make sure you select the correct option, or you could end up paying costly fees down the road.

Guidelines for classifying workers are available in Publication 15-A from the IRS. Basically, the more control you have over a worker, the more likely they are an employee and not a contractor. Questions to consider include: Will you be paying your worker on a regular basis, rather than by the project? Will they be working only for you? Will they be working on company premises, during specific hours, with equipment you provide?

Taxes

If you are indeed hiring employees rather than independent contractors, you will be responsible for paying associated taxes, which can be organized using payroll software.

FICA. You pay half of the taxes classified under the Federal Insurance Contributions Act (FICA), which encompass Medicare and Social Security. The other half will be withheld from the worker's paychecks.

Federal unemployment. Employers pay federal unemployment tax on the initial $7,000 that every employee earns in a calendar year.

State unemployment. These taxes may vary based on factors including size of the company, location and number of employees.

Disability. In some states, employers also pay disability tax on a quarterly basis.

Tax forms

Form W-4. Before their first day of work, employees fill out a withholding exemption certificate known as form W-4, which specifies how much money is to be held back from their paycheck for taxes. These calculations can be entered into your
payroll software. Federal law specifies that W-4 forms should be kept on file during the entirety of a person's employment and for four years after they have left the job.

Form W-2. On a yearly basis, you will also have to report all of the wages you have paid and taxes withheld for each employee, using a Wage and Tax Statement - or form W-2. One copy of this form is sent to the Social Security Administration in the first few months of the year to report on the previous year, while another copy is sent to the employee by January 31st.

Form 941. This is the Employer's Quarterly Tax Return, which you generally fill out and file every three months. If you have less than $1,000 in income tax liability, you fill out form 944, Employer's Annual Federal Tax Return, instead.

Form 940. If you paid at least $1,500 in wages during a single calendar quarter or had at least one employee for 20 or more weeks in the year, you must file form 940, the Employer's Annual Federal Unemployment Tax Return.

Legal considerations

Zoning laws. If you already run a home-based business, you may have already looked into zoning laws in your neighborhood. Revisit these laws before taking on an employee in your home to make sure you are able to do so. Sometimes, zoning laws only become an issue if a company hires an employee who is unrelated to the owner to work on the premises.

Employee ID numbers. Before you can hire employees, you will need to obtain an employment identification number (EIN) - otherwise known as an Employer Tax ID or form SS-4 - from the IRS. This number is used by the government to track federal payroll taxes. You can apply for an EIN online.

You will also need to investigate the requirements for a separate state employee ID for state payroll taxes, as well as checking to see if your local government requires a separate ID too.

Eligibility to work. Another pre-employment step is to verify if the person you plan to hire is legally able to do so in the U.S. All new employees are required to fill out form I-9, which also specifies that you verify their documentation. It is recommended that employers photocopy these documents and keep them on file. An I-9 form should be maintained for all current employees and retained for three years after their hire date or one year after they leave.

Reporting employees to the state. Employers must report new employees to the state so the government can monitor unemployment compensation, workers' compensation and similar programs. You may face fines if you do not provide a copy of the employee's W-4 within 20 days of their hire or rehire date. Check with your state for full requirements.