Can A Sole Proprietor Have Employees?

It’s a common question: ‘Can a sole proprietor have employees?’ 

The answer is yes, you can hire employees as a sole proprietor, but there are key legal and tax implications to consider.

Are you a sole proprietor?

A sole proprietorship is the simplest form of business structure. It’s a one-person business that’s not incorporated. You as the owner, or the sole proprietor, are legally responsible for the business’s liabilities, losses, and debts. 

On the flip side, you enjoy all the profits. Unlike other business structures, sole proprietors conduct business under their legal name and pay personal income tax on the profits they earn. This structure is straightforward, with minimal paperwork required. 

However, depending on your local jurisdiction, you might need a business license or an occupancy permit.

Can sole proprietors have employees?

Legally, you can hire employees as a sole proprietor. However, doing so could expose you to significant liabilities. If you encounter legal challenges from employees at any point, your personal assets may be at risk if you continue to operate as a sole proprietor. Electing a different business entity offers additional protection and helps you take advantage of other resources available to corporation owners.

As mentioned, a sole proprietor can absolutely hire employees. But before you do, it’s important to familiarize yourself with the local tax and labor regulations. 

Here’s a breakdown:

• Tax Implications: When you hire employees, you’re stepping into a realm of new tax responsibilities. This includes withholding payroll taxes from your employees’ wages and ensuring they’re remitted to the appropriate authorities.

• Employment Forms: As an employer, you’ll be required to provide and maintain specific employment forms. For instance, employees need to fill out Form W-4 for tax withholdings, and you must verify their eligibility to work using Form I-9.

• Worker’s Compensation Insurance: Prior to adding an employee consider obtaining workers’ compensation insurance. If an employee is injured while on the job, you could be held accountable for their medical expenses and lost wages. The requirement for coverage is determined by each state. In Texas, worker’s compensation insurance is optional for sole proprietors, but clients may require you to carry this coverage before they will conduct business with you.  

Employees vs. independent contractors

When expanding your team as a sole proprietor, there’s an important distinction you need to make between hiring an employee vs hiring an independent contractor.

Employees are directly on your payroll, and you’re responsible for their tax withholdings, benefits, and other obligations. 

Independent contractors, on the other hand, are not employees. They handle their own taxes and operate as separate entities. The way you report payments to them, and the tax implications, are distinct from that of your employees.

So when you decide to have employees as a sole proprietor, start by considering whether it makes sense to hire someone on payroll, or an independent contractor.

Whichever option you choose, make sure that your bookkeeping services are on top of things so that all payments, taxes and transactions are accurately calculated and recorded.

Steps to hire employees as a sole proprietor

If you decide to have employees as a sole proprietor, there are several steps you’ll need to consider.

1. Obtain an EIN: You’ll need an EIN from the IRS, which you can do online or by mail.
2. Employee documentation requirements: You’ll need to have your employees fill out a W-4 form for tax withholding purposes and an I-9 form to verify their eligibility to work in the United States.
3. Setting up a payroll system: You’ll need to set up a payroll system to pay your employees and withhold taxes. You can use a payroll service or software to help you manage this process and avoid calculation errors that would result in fines when you file taxes.
4. Withholding taxes and other deductions: You’ll need to withhold federal and state income taxes, Social Security and Medicare taxes, and any other deductions your employee has authorized, such as health insurance premiums or retirement plan contributions. 
5. Record-keeping requirements: You’ll need to keep accurate records of your employees’ hours worked, wages paid, and taxes withheld. You’ll also need to keep copies of their W-4 and I-9 forms.

Tax implications for sole proprietors with employees

As a sole proprietor with employees, you’ll need to file taxes for your employees. Independent contractors are responsible for filing their own taxes. Sole Proprietor’s are responsible for reporting to the government if they paid an independent contractor $600, or more in a fiscal year using the proper 1099 form.

You’ll need to file Form 941, Employer’s Quarterly Federal Tax Return, to report the federal income taxes, Social Security and Medicare taxes, and any other taxes you’ve withheld from your employees’ paychecks.

You’ll also need to file Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, to report and pay FUTA tax, which helps fund unemployment benefits for workers who lose their jobs.

Hiring family members: spouses and children

Hiring a family member can be beneficial for your business, but it comes with its own set of rules. If you’re considering hiring your spouse or children, consider the following:

• Hiring a Spouse: If both you and your spouse own the business, you can’t hire your spouse as an employee. However, if your spouse isn’t a partner, they can be on the payroll.
• Hiring Children: Hiring your children can offer tax benefits. For instance, you won’t pay FUTA tax for children under 21, and those under 18 won’t pay FICA tax.

Hiring employees as a sole proprietor can be a great way to grow your business, but remember, it’s important to understand all the legal and tax implications before you do so. 

By following the steps outlined in this guide and complying with employment laws and regulations, you can successfully hire and manage employees as a sole proprietor.

If you’re a sole proprietor looking for help with bookkeeping, reach out to us. We offer online bookkeeping services to help small business owners like you manage your finances and grow your business. Contact us today to learn more.

FAQs

Here are some common questions related to hiring employees as a sole proprietor:

Do I need to provide benefits to my employees?

No, you are not required to provide benefits to your employees, but you may choose to offer them as a way to attract and retain talent.

What is the difference between a W-2 employee and a 1099 independent contractor?

 A W-2 employee is considered an employee of your business and is subject to tax withholding and other employment laws. 

A 1099 independent contractor is self-employed and is responsible for paying their own taxes.

Do I need to offer paid time off to my employees?

No, you are not required to offer paid time off to your employees, but you may choose to do so as a way to attract and retain talent.

How many employees can a sole proprietor have?

There’s no limit to the number of employees a sole proprietor can hire, as long as tax obligations are met.

Can a sole proprietor be a W2 employee?

No, the IRS views a sole proprietor as self-employed, so they can’t be W2 employees.

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