Hiring your first employee triggers several regulatory and tax requirements in a small business at the federal, state and local levels. Follow these steps to ensure compliance:
- Obtain an Employee Identification Number (EIN) Issued by the U.S. Internal Revenue Service (IRS), this number is necessary to file taxes and pay federal and state income taxes on behalf of employees.
- Set up a record-keeping system for tax withholding All businesses are required to withhold taxes and to maintain records of withholding for four years. Most computerized accounting systems include a payroll module that manages the records and withholding automatically. If you do not use a computerized accounting system, then seek the help of a bookkeeper or certified public accountant (CPA).
The computerized systems generally build in the tax tables and rates to accurately tabulate withholding requirements. The IRS and states publish guidelines annually if manual calculation and withholding occurs.
- Gather the appropriate withholding forms from each employee Each employee should provide a Form W-4, which is available on the IRS website, on the first day of employment. On this form s/he declares the number of exemptions claimed for withholding which in turn determines the tax rate.
- Start withholding taxes With every paycheck issued, the employer must withhold taxes, add the required employer payments, and set aside the funds for payment to the government immediately or in the near future. The IRS determines the frequency of payments based upon your total payroll dollar. Companies incur penalties for not paying taxes on time. The types of taxes include:
- Federal income tax These are withheld from each employee based upon W-2 Form declarations.
- Social Security and Medicare taxes These are partially withheld from the employee’s check and matched by the employer.
- Federal Unemployment Tax These taxes are the responsibility of the employer, not the employees, and the frequency of payment is determined by the IRS for each business.
- Self-Employment Tax This tax is paid by individuals who work for themselves and is similar to the Social Security and Medicare taxes paid for employees. It is paid on the Individuals Form 1040 files annually.
- File annual wage and tax statements Each year, employers must report to their employees a statement of wages held and taxes paid, called a W-2 form. The deadline to provide W-2 forms to employees is January 31 of each year. All the forms for employees are also submitted to the U.S. Social Security Administration in the Annual Wage and Tax Statement. The deadline to submit your annual statement is February 28 of each year. State and local tax statements may also be required and information is readily available through their respective agencies.
- Gather employee eligibility information Employers must also verify each employee’s eligibility to work in the United States by completing a Form I-9 and keeping it on file. This form documents acceptable forms of identification to confirm citizenship or eligibility to work.
- Register with your state’s New Hire Reporting Program Within 20 days of hiring or re-hiring an employee, each state requires the employer to notify this agency.
- Obtain Workers’ Compensation Insurance Each business is required to carry this insurance through a commercial carrier, on a self-insured basis or through their state’s Workers’ Compensation program.
- Post required notices Each employer is required to post notices about work place rights and employer responsibilities under labor laws in a prominent location. Both state and federal posters are required and can be obtained online.
- File your taxes On a quarterly basis employers file Form 941 with the IRS stating total wages paid and taxes withheld over the past 90 days. In addition, annually a federal unemployment tax statement must also be filed using Form 940 for the IRS. Generally, state and local forms are required as well.
Employers are responsible for understanding the employment tax regulations and implementing them correctly. Fines and penalties can be substantial for non-compliance.
Numerous resources exist to help learn about and keep up with employment taxation including websites for federal, state and local agencies, certified public accountants, accounting industry associations and consultants. Many small businesses turn to the Small Business Development Centers in their locale for assistance as well.
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