Can a Sole Proprietor Have Employees?

Whether you decide to open a small business or embark on the digital nomad life, you’re technically a small business owner. As your operation grows, you may need to bring on more people who can offer expertise or help handle the workload.

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So, do you need to create an LLC or formally incorporate your business before you hire employees? 

The good news is that you don’t. Sole proprietors can hire employees.

Keep reading to learn more about the sole proprietorship business structure and how to hire employees as a self-employed business owner.

What Is a Sole Proprietorship?

The IRS defines sole proprietorship as an unincorporated business owned by a single person, and it doesn’t distinguish between the business and the owner when taxes come around. 

Unlike LLCs and corporations, sole proprietors don’t need to formally create a legal entity for their business. 

For example, if you’re a freelance graphic designer, you are automatically a sole proprietor. Still, some sole proprietors need to file for a federal business license or permit to operate, like commercials fishers and people transporting agriculture.

Because it doesn’t require extra legal steps to create, the sole proprietorship is a common type of business used by entrepreneurs and small business owners, especially when getting started.

Can a Sole Proprietor Have Employees?

Like other small businesses, sole proprietors can hire both employees and independent contractors. Employees work for your business full or part-time and earn a salary. You direct their work and expect them to be in certain places, at certain times. An independent contractor decides how and when they work, and charges you a fee for their services.

One main difference between a sole proprietorship and other structures like an LLC or Corporation is that you can't hire yourself. 

Sole proprietors are business owners that must be paid from the business’s profit. Other business owners are technically considered members, which means they can choose to hire themselves and receive a salary or remain an owner and take owner's draws.

How To Hire Employees When You’re Self-Employed

As a business owner, you are not limited to the number of employees or independent contractors you hire. However, when you hire someone, you must take a few additional steps in terms of taxes and recordkeeping.

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Here are some of the required steps to follow when hiring employees.

Step 1: Get an EIN From the IRS

If you’re self-employed and want to hire employees, you need to obtain an Employer Identification Number (EIN) from the IRS. 

Otherwise, your social security number (SSN) serves as the business identifier for tax purposes if you don't have employees.

Step 2: Provide Employment Forms

Every employee you hire must submit IRS Form W-4 to you. This form tells you, the employer, how much to withhold from their paycheck for federal taxes. 

You only need W-4 tax forms from employees who receive paychecks, not independent contractors who send you invoices. 

Instead, you should make sure you receive IRS Form W-9 from independent contractors. The W-9 form provides you with their taxpayer identification number (TIN), so you can report the money you paid them.

Step 3: Figure out Benefits

Besides deciding how much to pay your W-2 employees, you need to include certain employee benefits in your compensation plan. 

The following benefits are required by federal or state law:

• Social Security taxes 
• Medicare taxes
• Workers’ compensation insurance
• Disability insurance (if you’re in California, Hawaii, New York, New Jersey, Rhode Island, or Puerto Rico)
• Leave benefits as outlined by the Family Medical and Leave Act (FMLA)
• Unemployment insurance

Some states require businesses to offer retirement plans to their workers. California, Connecticut, Illinois, Massachusetts, Oregon, and Washington have state-sponsored retirement plans, while many other states have passed similar legislation that hasn’t been implemented yet.

Benefit requirements apply to W-2 employees only, not independent contractors. The definition of an employee varies by state. For the best information for your business, check your state’s website for employment definitions and requirements.

Besides the required benefits, you can offer other benefits to incentivize employees at your company. These include health insurance, private retirement plans, extended leave, and pre-tax transportation. 

Step 4: Set Up Your Payroll System

Once you decide on employee salaries and pay periods, you need to set up a pay system. You can use manual tools like paper timesheets and checks, but that can become an administrative headache. 

Payroll software providers like Hourly make it easy for you to run payroll and manage your workers’ comp insurance for all types of employees, including part-timers. 

Step 5: Withhold Payroll Taxes

Whether you run payroll manually or use software, you’re responsible for withholding federal income taxes each time you pay an employee. Specifically, you must withhold the FICA taxes, which are Medicare and Social Security. You can use the IRS Tax Withholding Assistant to calculate federal taxes or use a payroll software solution like Hourly that automatically takes care of that.

If you choose to offer opt-in benefits, such as private health insurance or retirement plans, you’ll want to set up those paycheck deductions as well.

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Social Security and Medicare taxes are deducted from employee paychecks, and you’ll need to pay your share of those benefits too. Employers also pay for workers’ compensation insurance. Unemployment and disability insurance are typically paid by employers, though that’s not the case for every state. For example, in California employees are taxed for disability insurance, not employers. To figure out your state taxes, check with your state’s department of labor website.

The FMLA only requires that employers offer 12 weeks of unpaid, job-protected leave each year for events such as the birth of a child, adoption, or death of a family member. Since no paid leave is required under FMLA, there is no paycheck deduction. 

Step 6: Keep Employee Records

When you hire employees, you need to follow certain recordkeeping requirements outlined by the U.S. government. 

In particular, you need to keep: 

• All personnel and employment records for one year
• All payroll records for three years
• Pension, insurance, and other benefit plans while it’s in use and for one year after the plan is terminated
• Any written seniority or merit plan while it’s in use and for one year after the plan is terminated

Once again, using software to handle your payroll and taxes can make it easier for you to store records and comply with federal law.

Filing Taxes for Employees and Independent Contractors

Since there’s no separate business entity when you have a sole proprietorship, you file business taxes on personal income tax returns. 

You report your business income using IRS Form Schedule C (Profit or Loss from Business) instead of a W-2. 

If you have W-2 employees, you need an EIN. Otherwise, your business’s taxpayer identification number is just your social security number.

Once you hire a W-2 employee or independent contractor to work for your business, you have additional bookkeeping requirements and must file additional forms with your income taxes, which we’ll cover next.

Tax Forms Required With W-2 Employees

Here are the additional forms you need to file with your tax return:

• IRS Form 941: File quarterly to report FICA taxes withheld from employee paychecks
• IRS Form 940: File annually to report FUTA (Federal Unemployment Taxes) withheld
• State unemployment tax form (filed annually, these forms vary by state)
• IRS Form W-3: File annually to report total wages paid to all employees

You must also distribute the following forms to your employees:

• IRS Form W-2: Distribute to employees by January 31. Provides them with wages paid and information on FICA taxes withheld.

You must collect IRS Form W-4 from each W-2 employee you hire, which tells you how much tax that employee wants you to withhold from their paycheck.

Filing Taxes with Independent Contractors

Unlike employees, independent contractors do not receive a regular salary from you, and they are responsible for their self-employment tax liability, which includes Social Security and Medicare taxes. 

Still, if you pay an independent contractor more than $600 for the fiscal year, you’re required to send them IRS Form 1099-NEC, which contains the total amount of money you paid them. Like W-2 forms, these should be distributed to contractors and the IRS by January 31. If you miss the deadline, you’ll have to pay a penalty for each late file.

Anytime you hire an independent contractor, you should ask them to provide you with their taxpayer identification number using IRS Form W-9. You’ll use this information when completing the 1099-NEC. 

Hiring Employees as an LLC vs. Sole Proprietor

Some small business owners choose to create a Limited Liability Company (LLC) to limit personal liability or operate under a business name by creating a separate legal entity for their company.  

LLC owners can also hire W-2 employees and independent contractors. The same tax filing regulations apply. 

Structuring your business as an LLC requires more paperwork than a sole proprietorship, but it also gives you the following advantages:

• Protection of your assets 
• Flexible tax filing (choose to file as a sole proprietor or corporation) 

The Small Business Administration website has resources that can help you choose which business structure is best for you. 

Yes, Self-Employed Business Owners Can Employ Others

Running a sole proprietorship doesn’t mean you have to be a one-person shop. It simply means you’re the sole owner of the business. As you grow, you can hire independent contractors and even bring on full-fledged employees. 

To make payroll and compliance easier for yourself, explore Hourly’s payroll solutions today.