Tax Considerations for Hiring Your First Employee

Hiring your first employee is a big step for a small business. It means that you’re growing; you’ve got more business than you can handle on your own, and you need to offload some of those business functions. The fact that you’re looking at hiring your first employee suggests your business is on the right track, and that it’s relatively stable.

Yet, you need to be careful during the hiring process. There are plenty of state and federal rules about how hiring works, for example. Not only that, you’re going to be responsible for withholding payroll taxes. In fact, there are a number of tax considerations you’re going to face now that you’ve hired someone else.

Here are some steps to take that will help get your tax situation in line when hiring your first employee:

1. You’ll need an Employer Identification Number (EIN).

You can get an EIN directly from the Internal Revenue Service. You use the EIN to report taxes to the IRS, as well as to various state agencies. For some sole proprietorships, your EIN will be your Social Security Number. In the long term, however, you are usually better off getting a separate EIN. That will help the transition when it comes time to change your business structure to an LLC or corporation.

2. From day one, you have to keep records of employment taxes.

The rules state that you have to keep your employment tax records for a minimum of four years. Not only will this help you in the event of an audit, but it will also help you when it comes time to pay those quarterly taxes and keep you from getting behind in paying your withholding taxes.

There are three areas you need to be concerned with in terms of withholding taxes. Before hiring your first employee, cover these bases:

The exemption certificate. Your employees need to fill out and sign a withholding exemption certificate, known as form W-4. They must do this no later than the first day they start to work for you.

The annual wage and tax statement. Every year at tax time, you’re required to provide a W-2 form to employees. This is a statement of their wages as well as their tax withholding. You also have to send a copy of employee W-2 forms to the Social Security Administration no later than the last day of February (or, if you file your taxes electronically, the last day of March). Employers also must send the W-2 to employees no later than January 31.

State and local taxes. Depending on where your business is located, you’re likely to be required to withhold state income tax payments, as well. Check with your state, as well as your municipality, to see if you’re facing any of those sorts of requirements.

3. You’ll have to pay a number of other tax-related fees, too.

For example, you’re required to pay unemployment insurance taxes for some businesses. This may or may not happen with your first employee; it depends partly on whether that employee is full-time or part-time, whether they are a member of your immediate family, and other factors, too. Check with your state’s workforce agency to find out what the rules are in your state, and to sign up to pay those taxes.

4. Be ready to file quarterly taxes.

Generally speaking, every quarter you pay wages to an employee you’re going to have to file the IRS Form 941. This is the Employer’s Quarterly Federal Tax Return, and it is how you pay income tax withholding, Social Security Taxes, and Medicare taxes. If your tax liability annually is $1,000 or less, you don’t have to file quarterly but can instead file Form 944 – Employer’s Annual Federal Tax Return.

You’ll also need to file the IRS Form 940 once a year. This is the Employer’s Annual Federal Unemployment (FUTA) Tax Return. You only have to file this if you paid out more than $1,500 in wages in a quarter, or if you had employees working with you for 20 or more weeks during the year.

As a small business owner who’s contributing to the economy by hiring your first employee, you also need to be aware of the tax obligations it creates. If you’re not diligent about setting aside payroll taxes, for example, you could find yourself facing significant penalties and fees, and in some cases might even wind up having to shut your doors.

Speak with a tax professional if you have any questions about hiring your first employee.

[IMAGE LICENSE: Some rights reserved by Robert S. Donovan]

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