Hiring Employees as a Sole Proprietor - A Complete Guide

One of the main benefits of being a sole proprietor is to have full control over your business. However, doing everything yourself can be exhausting and overwhelming. Once you catch yourself pushing the 15-hour workday, consider hiring someone to help you with the workload.

But, as a self-employed person, can you even hire people? While the internet has a hard time agreeing on this, the answer is: Yes. You can hire as many employees as you’d like as a sole proprietor.

However, moving from a sole proprietor to the status of employer can be tricky. You should know everything there is about hiring employees as a sole proprietor. You want to be a good employer and maintain compliance with local laws and regulations.

Here’s all you need to know about hiring employees as a sole proprietor.

What requirements should you meet when hiring someone as a sole proprietor?

When you decide to hire someone as a sole proprietor, you are still required to meet federal and state requirements. You will also need to manage proper administrative tasks and procedures. Plus, you need to perform all the relevant tax filings.

The first step to hiring someone typically involves getting an Employer Identification Number (EIN) from the IRS. If your state has specific requirements in terms of licenses and permits, it is advisable to get them beforehand.

In terms of your employees, you’ll need to verify that they are eligible to work in the US. You’ll also need to collect their Social Security number. You may also need to obtain other relevant information for income tax withholding purposes.

How to pay your employees as a sole proprietor?

Before you start hiring, you also need to understand all the complexities of paying your employees. The IRS offers a great hiring guide. But, here’s what you need to know explained more simply.

1. You should ask your employees to fill out and submit relevant paperwork

Both new employees and old ones are required to submit the following forms to their employers:

• Form W-4

• State tax withholding form

• Form I-9

As an employer, you might need to register state and local payroll tax accounts for tax tracking and reporting purposes.

2. Calculate your new employees’ pay

It’s important to understand the type, amount, and how often you will be compensating them for their work. You can pay your employees an hourly wage, pay them through commission, or agree with them on a fixed annual salary.

Typically, employers pay their employees weekly, bi-weekly, semi-monthly, or monthly.

You should also determine the amount you should withhold for tax purposes. Depending on the state and local regulations, you should consider:

• Federal Insurance Contribution Act (FICA)

• Federal Unemployment Tax Act (FUTA)

• Deductions for healthcare and other statutory benefits

• Federal income tax

• State income tax

• The local tax may apply.

You pay your employees their salary minus these tax withholdings. Employers generally pay their employees through direct deposit checks.

3. Meet tax requirements for your business and employees

The last step is to follow local regulations on taxes you are required to file and pay. Depending on your business, you may have to file with the IRS, state, and city tax collection agencies.

If paying your employees seems overwhelming, outsourcing payroll to a payroll service provider might be a good choice.

Employing family members in your sole proprietorship

Sole proprietors often hire family members to help out with the workload. Turning a sole proprietorship into a family business is not uncommon, and it even has some tax benefits.

Hiring a spouse as a sole proprietor

Often spouses decide to co-own a sole proprietorship, and they are equal partners in the business. If that’s the case with your spouse, both you and your spouse earn your salaries as an owner’s draw, and you can’t hire them as an employee.

But, if you don’t co-own the sole proprietorship, you can put your spouse on a payroll. In that case, the spouse has to meet income and Federal Insurance Contribution Act (FICA) taxes. On the other hand, your spouse doesn’t have to pay the Federal Unemployment Tax Act (FUTA) tax on their wages.

Hiring children as a sole proprietor

Many sole proprietors decide to hire their children as their first employees. It teaches them to work for their pay and responsibility, but also allows you to see them more during the day.

While this is very possible, there are a couple of things you should consider.

1. When you hire your children, you still have to withhold your child’s income tax pay.

2. Your child will not be paying for FICA tax if they are younger than 18.

3. You don’t have to pay FUTA tax if they are younger than 21.

Hiring your children in your business teaches them work ethics, which the IRS will reward with certain tax benefits. But, inform yourself of the actual rules and guidelines on hiring your children in your state, as they may differ.

Hiring employees vs. contractors as a sole proprietor

Hiring someone as an employee has its benefits over hiring contractors. However, sole proprietorships might benefit more from hiring contractors. Hiring someone to tick things off your to-do list without having to put them on payroll can be a great choice for booming businesses.

Yet, independent contractors are a temporary solution. While they don’t require you to jump through hoops to hire them, you have to be mindful of employee misclassification even as a sole proprietor.

Once your contractors become invaluable to your business, consider turning them into employees.

Should you upgrade your entity type to LLC?

While employees can be a great way of outsourcing some of the daily workload, there are many risks associated with hiring. Maintaining compliance with local laws and regulations is one of them.

As your business grows, consider upgrading your entity type to LLC. This entity type is slightly more difficult to start, but it offers better liability protection than the one available to a sole proprietorship.

With a sole proprietorship, you and your business are the same in the eyes of the law. If any mishap happens, you will be personally liable for damages and other expenses.

While you can buy business insurance, once you start hiring many employees, it may be beneficial to upgrade to an LLC. This will provide you with not only personal asset protection but also with the credibility of having a more official business. Plus, it offers several benefits when it comes to taxation.

FAQ:

Can a sole proprietor have investors?

Sole proprietors may get outside investments. But, they are not allowed to offer stock to their investors or take on partners.

In that case, sole proprietors should consider changing their entity type to either partnership or LLC. It will be easier to get investments and loans for these business types.

How many employees can a sole proprietorship have?

A sole proprietorship can have as many employees as it needs. Sole proprietors need to get familiar with the compliance and tax requirements before they start hiring.

What are the disadvantages of sole proprietorship?

The main disadvantage of a sole proprietorship is that you are not eligible for benefits like regular employees are. This includes pension and healthcare plans, sick days, and vacation days, all of which you have to fund yourself.

Additionally, it might be difficult to find the time to promote your business and find clients. You'll also need to find time for relevant HR processes or for finding investments. Lastly, closing up your sole proprietorship shop and trying another business is easy. But, it may be difficult to sell your sole proprietorship to someone else.