Handling payroll as a sole proprietor who works alone is a piece of cake. There is nothing to it. All of your business revenue is considered personal income and taxed as such. You pay regular income tax plus self-employment tax to cover Social Security and Medicare. However, things change when you decide to bring on employees other than immediate family members.
The sole proprietor whose business expansion involves hiring must change the way he does things. He is no longer responsible only for himself; he is also responsible for those employees he brings on board – at least in a payroll and tax sense. Not keeping up with those responsibilities could land him in trouble.
Below are five payroll fundamentals for expanding sole proprietors. They might apply to you if you have plans to hire in the future.
1. The Employee Identification Number
Sole proprietors file their taxes using their Social Security numbers. That will not do for an employer. Once employees are brought on, the business must have an employee identification number (EIN). This is a number used to identify the employer for all federal tax purposes. Many states rely on the federal EIN as well, though some issue their own state numbers.
Applying for an EIN is painless. You can do it online or over the phone. What’s more, there is no waiting involved. Complete your application and you will have your number right away. You will get a paper document in the mail a few days later.
2. Employee Classification
According to BenefitMall, one of the most frequent mistakes among new employers is incorrectly classifying workers. For federal tax purposes, a worker is either a traditional employee or independent subcontractor. Employees are covered under all of the provisions of the Fair Labor Standards Act (FLSA); contractors are not.
The law does not allow employers to arbitrarily classify workers as contractors. In order to be a contractor, a person has to meet certain qualifications.
3. Pay Period and Payroll Scheduling
Setting up payroll requires employers to determine two things: the regular pay period and a schedule for payroll processing. For example, your company’s pay period might run from Monday through Sunday. Another company might choose Sunday through Saturday.
As for payroll scheduling, the most frequently used schedules are weekly and biweekly. Semimonthly is another choice. Some states even allow monthly payroll, but they are the exception to the rule. The thing to remember is that it is best to choose a payroll schedule and stick with it. Changing it too frequently raises eyebrows.
4. Payroll Taxes
Next, sole proprietors just getting into the employment game should understand that they will be subject to certain payroll taxes. Employers must withhold income taxes and FICA at bare minimum. Federal unemployment tax might also be required.
Employers must contribute their share of FICA in addition to withholding from employee paychecks. FICA covers both Social Security and Medicare. Employers and employees split the cost down the middle, where the sole proprietor pays the entire bill himself.
5. Outsourcing Payroll
Finally, sole proprietors turning employers do not have to handle payroll in house. They can always outsource the task. Outsourcing payroll can save time, reduce errors, and minimize the headaches that come with payroll and taxes.
Are you a sole proprietor preparing to become an employer? If so, you have a lot to think about. Help yourself and your business by researching everything related to payroll. You want to make sure you get it right from the very start. Doing things incorrectly and fixing the mistakes later on creates a world of headaches.