I remember the excitement of hiring my first employee.
Bringing on staff can feel like a big step toward that scalable business you’ve always wanted. Now you can delegate tasks and increase your output. But do you know what you need about State and Federal taxes before your make your first hire? It’s one thing to go into business for yourself. It’s something else entirely to take on the responsibility of another person’s income.
Once you’ve decided that an employee is the right next step for your business, you’ll need to be financially prepared for the financial implications.
Both you and your new employee have state and federal tax obligations. Here are the basics.
What you owe:
At the federal level, you must pay social security and medicare on behalf of your employee. You are also responsible for paying what’s called a FICA match. FICA stands for Federal Insurance Contributions Act, and you have to pay an amount equal to your employee’s social security and medicare tax.
Under federal law, you must pay for unemployment insurance for all employees. Most states also have an unemployment insurance program. This payment goes into an unemployment fund that your state maintains to provide temporary benefits to people who lose their jobs.
Some municipalities also require payroll taxes that are tied to employment, such as a commuter tax.
What your employee owes in State and Federal taxes:
Your employee is required to pay income, social security, and Medicare taxes out of their wages. But if you’ve ever been an employee, you know employees don’t make these payments on their own at tax time.
You, as their employer, serve as a withholding agent. You are required to withhold the taxes they owe the government from their paychecks and then submit those taxes on a monthly or quarterly basis to the state and/or federal government.
In addition to actually submitting the funds, you have reporting requirements. When you make submissions during the year at monthly, quarterly, or biweekly intervals, you are making estimated payments that have to be reconciled with what you actually owe at the end of the year, similar to the way an individual must file a personal income tax return.
What you must do to comply:
If all this has you feeling a little overwhelmed, you’re not alone. Many entrepreneurs and small business owners outsource their payroll processing requirements as a way to ensure compliance with State and Federal taxes.
There are three basic ways to meet your payroll tax burden:
- Do it yourself. This could mean manually filling out the paperwork or using accounting software. Either way, you’ll need to know the applicable laws and make sure you’re keeping up with submitting requirements.
- Use an outsourced payroll service. Companies like Paychex, ADP, Gusto, Paydata, and Quickbooks Online have options for managing payroll payments.
- Use a bookkeeping service to manage a payroll service. A bookkeeping service can make sure that payroll taxes are calculated and submitted appropriately and ensure that the information is accurately incorporated into your accounting records.
Growing your team provides innumerable benefits – from increased output to the intangibles of having someone else to share the ups and downs with. Bringing on one employee may seem like a relatively small addition to your administrative load, but it’s important to get proper systems in place so that you don’t make mistakes that get you in trouble with state or federal tax authorities.
However you decide to handle payroll, we’re here to help.
[And a quick word of caution if you decide all this is too troublesome and you’ll just hire an independent contractor. Many entrepreneurs start off using independent contractors before they hire their first employees. I’m all for outsourcing tasks – after all, it’s how my business thrives. But if you’re working with freelancers, check on the state and federal tax regulations to make sure you’re not avoiding the payment of necessary taxes.
Both your state tax department and the Federal Government have rules defining who is an employee and who is an independent contractor. Making the correct determination matters. If the IRS considers your independent contractor an employee, you can be on the hook for substantial penalties and back taxes.]