How to Get Ready for Hiring Your First Employee
For small business owners, growing a business is exciting. But when that growth requires expanding your team, the legal and financial aspects of hiring can be nerve-racking. Will the person you hire be an employee or an independent contractor? Do you have enough work to keep them busy long-term? Will they care about your clients or customers as much as you do?
As you approach this milestone, it's a good idea to get an understanding of what it takes to hire your first employee.
Consideration #1: The legal ins and outs
There are all sorts of rules and regulations in business, and hiring is no exception. If you don't understand the legal implications of hiring an employee, you could accidentally find yourself on the wrong side of the law.
The federal government and states set employment laws, so visit Employer.gov and your state's labor office to find information on the minimum wage in your state, the types of information you can and can't collect while hiring, and other requirements.
One issue you may face when hiring is correctly classifying new hires as independent contractors or employees. For employees, you must withhold federal and state income taxes, Social Security and Medicare from wages paid. For independent contractors, employers do not withhold taxes. However, it's not as simple as deciding to classify your new hire as an independent contractor. If you have the right to control what the worker does, how they do their job and how they are paid, the worker is most likely an employee.
Misclassifying employees as independent contractors can result in fines, back taxes and even criminal charges, so it's best to talk to a CPA or a labor attorney to ensure you get started in the right direction.
Consideration #2: Contracts
Whether you hire an employee or engage an independent contractor, you may need to ask your new hire to sign a contract.
Employment contracts detail what you expect from the employee — and what happens when an employee fails to live up to those expectations.
If you decide to have employees sign a contract, it should include:
- The job title and description
- Compensation and benefits
- Confidentiality requirements
- Intellectual property protection
- A non-compete clause
- Steps for terminating employment
This sample employment contract from the Stanford Social Entrepreneurship Hub is an excellent place to start, but you should also consult with an attorney in your state for specific guidance.
Independent Contractor Agreements
Written agreements are even more crucial when working with independent contractors. While not required by law, they help clear up confusion over worker classification, payments, deadlines, taxes and who owns the rights to work completed by the contractor.
Your written independent contractor agreement should contain at least the following terms:
- A description of the services to be performed
- How much you will pay
- Whether it's a fixed fee, by the hour, or based on other metrics
- How and when you will pay
- Who is responsible for expenses
- Who provides materials, equipment and office space
- A statement outlining the independent contractor relationship
- A statement detailing the contractor's responsibility for paying state and federal income taxes
- Steps for terminating the agreement
This sample independent contractor agreement from Berkeley Law can help you draft a custom agreement that reflects your needs and situation, but you should also consult the laws of your state.
Consideration #3: Insurance
Insurance requirements can vary widely depending on your industry or state, but there are three major types of insurance typically required when you hire an employee.
- Workers compensation insurance provides medical benefits and lost wages to employees who are injured or become ill at work. Depending on your state, you may be required to carry workers compensation insurance as soon as the business hires one person who is not an owner of the company. You may purchase coverage through a commercial carrier or a state program.
- Unemployment insurance is a joint federal and state program that provides temporary benefits to eligible workers who become unemployed through no fault of their own. Each state sets its own requirements for eligibility, benefit amounts and the length of time workers can receive benefits. Employers must pay the Federal Unemployment Tax Act (FUTA) if they pay at least $1,500 in wages to an employee in any calendar quarter or had one or more employees for at least some part of the day for 20 or more weeks. In most states, if you are subject to FUTA, you are also subject to the State Unemployment Tax Act (SUTA). The U.S. Department of Labor maintains a list of state unemployment tax agencies.
- Disability insurance. Some states require employers to provide disability coverage for illness and injuries that are not related to the workplace. These states are California, Hawaii, New Jersey, New York and Rhode Island — plus Puerto Rico.
Consideration #4: Taxes
Independent contractors are responsible for paying their own federal, state, and employment taxes, but employers must withhold and pay employment taxes for part- and full-time employees.
You can get more information on withholding and paying federal employment taxes in IRS Publication 15, Circular E, Employer's Tax Guide and find links to your state's tax agency via the Federation of Tax Administrators.
Handling payroll in-house is complex, so many employers outsource it to an outside payroll service provider. They take care of computing payroll taxes, withholding them from paychecks, remitting taxes to the government, and filing employment tax returns. Just remember, even if you outsource these tasks, you remain ultimately responsible. Make sure you work with a reputable company and monitor compliance closely.
Hiring the first employee is a huge milestone for any small business. The legal and logistical requirements may be daunting at first, but take the time to research your requirements and get systems in place as best you can from the beginning. When it's time to expand again, it will get easier with every subsequent hire.