Hiring Your First Employee

What Changes When You Hire

Hiring your first employee is one of the biggest operational milestones in a small business. It also triggers a significant set of new legal and tax obligations that don’t exist when you’re working alone. The good news is that none of it is beyond a small business owner to manage, especially with the right tools in place from the start.

This guide walks through everything you need to do before, during, and after bringing on your first hire.

Employee vs. Independent Contractor

Before anything else, decide whether the person you are bringing on is an employee or an independent contractor. This is not a choice you get to make freely based on what is convenient. The IRS and most state labor agencies have specific tests to determine worker classification, and misclassifying an employee as a contractor is one of the most common and costly compliance mistakes small businesses make.

Generally speaking, a worker is an employee if you control how, when, and where they work. A contractor is someone you hire for a specific outcome and who controls how they achieve it.

Employees require payroll taxes, benefits compliance, workers compensation, and unemployment insurance. Contractors handle their own taxes and you simply pay their invoices. The temptation to classify everyone as a contractor is understandable, but the penalties for misclassification include back taxes, penalties, and interest going back years.

If you are unsure how to classify a worker, you can file IRS Form SS-8 to request a determination. A business attorney or CPA can also advise you based on your specific situation.

Before Your First Hire: The Setup Checklist

Several things need to be in place before your first employee starts. Work through this list in advance so there are no delays on day one:

• Get an EIN if you don’t have one. You cannot run payroll without an Employer Identification Number. Apply free at irs.gov and receive it immediately.
• Register with your state labor and tax agencies. Most states require employers to register separately with the state department of labor and the state tax agency before running payroll. Search for your state’s employer registration requirements.
• Set up a payroll system. You will need payroll software or a payroll service to calculate withholdings, generate pay stubs, and remit taxes on schedule. More on this below.
• Get workers compensation insurance. Required in almost every state as soon as you have one employee. See the Business Insurance guide for details.
• Set up unemployment insurance. Federal FUTA and state unemployment taxes are required for most employees. Your payroll system handles the calculations but you need to be registered with your state unemployment agency first.
• Open a separate payroll bank account. Optional but recommended. Funding payroll from a dedicated account keeps those funds clearly separate from operating cash and makes reconciliation easier.

The Paperwork Every New Hire Completes

On or before the first day of work, every new employee must complete the following:

Form I-9 (Employment Eligibility Verification). Required by federal law to verify that the employee is legally authorized to work in the United States. You must inspect original identity and work authorization documents in person. The employee completes Section 1 on or before their first day. You complete Section 2 within three business days of the start date. Keep the completed I-9 on file for each employee.

Form W-4 (Employee Withholding Certificate). The employee uses this form to tell you how much federal income tax to withhold from each paycheck. Your payroll system uses the W-4 information to calculate withholding automatically. Employees can update their W-4 at any time.

State withholding form. Most states have their own equivalent of the W-4 for state income tax withholding. Check your state’s department of revenue for the correct form.

Direct deposit authorization. Most employees prefer direct deposit. Collect their bank account and routing number on a standard direct deposit form.

New hire reporting. Federal law requires employers to report all new hires to their state’s new hire reporting agency within 20 days of the hire date. Most payroll systems handle this automatically.

Payroll Taxes: What You Owe

Running payroll means withholding taxes from employee paychecks and remitting them to the IRS and your state on a regular schedule. Here is what is involved:

Federal income tax withholding. Based on each employee’s W-4 and the IRS withholding tables. Your payroll software calculates this automatically.

FICA taxes (Social Security and Medicare). You withhold 6.2% Social Security and 1.45% Medicare from each paycheck, and match it with an equal employer contribution. Total FICA cost to the employer is 15.3% of wages up to the Social Security wage base ($168,600 in 2024).

Federal unemployment tax (FUTA). 6% on the first $7,000 of each employee’s wages per year. A credit of up to 5.4% applies if you pay state unemployment taxes on time, reducing the effective rate to 0.6%.

State income tax withholding and unemployment tax. Rates and rules vary by state. Your payroll system handles the calculations once you are registered with the state.

Federal payroll tax deposits must be made on a semi-weekly or monthly schedule depending on your total payroll tax liability. You also file Form 941 quarterly to reconcile deposits, and Form 940 annually for FUTA. At year end, you issue each employee a W-2 by January 31.

Payroll tax deposits have strict deadlines. Late deposits trigger penalties starting at 2% and increasing the longer you wait. This is one area where getting the mechanics right from day one matters.

Choosing Payroll Software

Do not try to run payroll manually. Payroll software calculates all withholdings, generates pay stubs, makes tax deposits, files payroll tax returns, and handles new hire reporting automatically. The cost is modest compared to the time and risk of doing it yourself.

Gusto is the most popular choice for small businesses. Fully automated, handles federal and state filings, good onboarding tools for new employees, and integrates well with QuickBooks and other accounting software. Starts around $40 per month plus a per-employee fee.

QuickBooks Payroll is a natural choice if you are already using QuickBooks for accounting, since payroll data flows directly into your books.

Run by ADP and Paychex Flex are solid options from established payroll companies, often used by businesses that want full-service support including HR tools.

Required Workplace Posters

Federal law requires employers to display specific informational posters in the workplace where employees can see them. These cover minimum wage, workplace safety, anti-discrimination laws, and employee rights. The Department of Labor provides free downloadable posters at dol.gov. Your state may also require additional posters under state labor law.

If your employees work remotely, you can satisfy this requirement by providing the posters electronically.

Employee vs. Contractor Payment at Tax Time

At the end of the year, employees receive a W-2 showing their wages and withholdings. Independent contractors who were paid $600 or more during the year receive a Form 1099-NEC. Both forms must be issued by January 31 of the following year. Your payroll software handles W-2 generation. You will need to issue 1099s manually or through your accounting software for contractors.

Common Mistakes

• Misclassifying employees as contractors. The savings are not worth the risk. Penalties can include years of back payroll taxes, interest, and fines.
• Missing payroll tax deposit deadlines. Penalties start at 2% and escalate quickly. Set up automatic deposits through your payroll system.
• Skipping the I-9. Required for every hire regardless of citizenship status. Failure to complete and retain I-9 forms can result in significant fines per violation.
• Not registering with the state before running payroll. State registration is separate from federal. Many first-time employers miss this step and face penalties for late registration.
• Forgetting workers compensation. Operating without required coverage exposes you to personal liability for any workplace injury.

Where to Go Next

Hiring triggers obligations under several federal laws covered in the Federal Law section, including FLSA (minimum wage and overtime), FMLA (family and medical leave for employers with 50 or more employees), and EEOC anti-discrimination requirements. Check the State Law section for your state’s specific employment laws, which often exceed federal minimums on issues like minimum wage, paid leave, and final paycheck timing.