Hiring your first employee:

Step-by-Step Guide

As your small business becomes successful, you may need to consider hiring one or more employees, and taking on the responsibilities of payroll tax withholding and reporting.

Hiring an employee is fairly straightforward. However, if you're unfamiliar with the process and applicable laws, you may find yourself subject to significant monetary penalties.

Below are the steps to follow when hiring your first employee:

Determining the Cost of Your Employee

Every hiring decision balances the benefits to your company in terms of increased capabilities, with the costs of salary, benefits and payroll taxes for each employee. If you're ready to hire an employee, you have already identified the benefits, but to make a practical business decision, you need to know exactly how much it will cost to pay the employee's wages and benefits, as well as associated payroll taxes. Depending on your state and local laws, payroll taxes can add for 20% or more to the total cost of hiring an employee.

Filing Paperwork

As soon as you have reached an agreement on pay and hired a new employee, there are several forms that need to be filed with the federal and, in many cases, state governments. Each new employee must complete a W-4 form. The information on the W-4 form is the basis for calculating the amount of withholding for that employee. Employers do not need to send a copy of the W-4 to the IRS. However, employers may be directed (in a written notice or in future published guidance) to send certain Forms W-4 to the IRS. The IRS also will be reviewing employee withholding compliance and you may be required to withhold income tax at a higher rate if notified to do so by the IRS.

Required Deposits

It is the employer's responsibility to remit trust fund taxes to the appropriate taxing agencies. Two key components of this responsibility are accuracy in the dollar amounts of the deposits and timeliness in making these deposits.

Money withheld from employees' paychecks should be deposited in an account separate from the account(s) that the business uses for day-to-day operations.

Tax deposits must be made according to the IRS timetable. If an employer does not follow this timetable, the employer may be subject to penalties and interest for making late payroll tax deposits. The IRS does not treat the matter of late payroll tax deposits lightly, given that the employer is a trustee of these employee taxes.

The deposit schedule for federal payroll taxes is either semi-weekly or monthly depending on the size of the employer's total tax liability. The size of an employer's payroll tax liability is based on the total amount of payroll taxes paid during the lookback period.

If you are a Form 941 filer, your deposit schedule for a calendar year is determined from the total taxes (that is, not reduced by any advance EIC payments) reported on line 8 of your Forms 941 in a four-quarter lookback period. The lookback period begins July 1 of the second preceding year and ends June 30 of the previous year. If you reported $50,000 or less of taxes for the lookback period, you are a monthly schedule depositor; if you reported more than $50,000, you are a semiweekly schedule depositor.

If you are a Form 944 filer, your deposit schedule for a calendar year is determined from the total taxes (that is, not reduced by any advance EIC payments) reported on line 8 of your Form 941 for all four quarters of the second preceding calendar year.

If you are a Form 945 filer, your deposit schedule for a calendar year is determined from the total taxes reported on line 4 of your Form 945 for the second preceding calendar year.

The following worksheet can be used to calculate deposit requirements for the year 2001. Please note that each year the lookback period changes for determining a company's deposit schedule.

Monthly Depositor:

  • If the total tax liability is $50,000 or less for the lookback period
  • New Employer whose tax liability for any quarter in the lookback period before starting or acquiring the business is considered zero.
  • Semiweekly Depositor:

  • If the total tax liability is greater than $50,000 for the lookback period
  • You have processed a payroll that incurred an accumulated tax liability of $100,000 on any day. Other situations may impact the frequency in which employers must file their payroll taxes. For example, whenever an employer has accumulated withholding of $100,000 or more on any one day during a deposit period, the full amount must be deposited by the close of business on the next banking day. This requirement applies whether you are a monthly or semiweekly depositor. The employer is also then required to follow a semiweekly deposit schedule for the remainder of the year and for the following calendar year. For more information about special deposit requirements, consult the IRS Pub 15.
  • Record Keeping

    Federal and some state laws require that employers keep certain records for specified periods of time. With regard to payroll, the W-4 form (on which employees indicate their tax withholding status) must be kept on file for all active employees and for four years after an employee is terminated.

    Filing and Reporting Requirements

    In addition to depositing money withheld from employees' pay and transmitting it to federal, state and local governments, payroll tax amounts must be reported to the appropriate agencies. The employer must report the earnings and withholding of each employee, payments made to contract workers, total withholding amounts and other information. As with payments and deposits, there are penalties for late or incorrect reporting.