So, in this post we discussed the trials and tribulations of finding the perfect employee for your company. Now we’ll take a look at the tax implications so you keep yourself out of hot water with the regulators, or said another way, what ever employer should know BEFORE they hire their first employee.
Eligibility to Work in the United States. Every employer must verify that each new employee is legally eligible to work in the United States. You don’t want to run into problems later so have the employees you hire fill out Form I-9, Employment Eligibility Verification. You can also get their SSN at this stage.
Employee vs. Independent contractor. While you may want to classify a person as independent contractor to avoid the hassle of dealing with payroll taxes, make sure the classification is proper. Generally speaking, an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. Not sure what your new hire will be? Check out this site for a little assistance.
Independent Contractors Agreement. If you do determine that the person who’ll work for you does qualify to be classified as an independent contractor, it’s a good idea to draft an agreement. This document should outline the duties they will/won’t perform, how they are compensated and the responsibilities with reporting their earnings to the IRS. This way you are protected in case the employee disagrees that they were an independent contractor or worse files a Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.
Fill out Form W4. To know how much income tax to withhold from an employees’ wages, you should have them complete Form W-4, Employee’s Withholding Allowance Certificate. Ask all new employees to give you a signed Form W-4 when they start work. Make the form effective with the first wage payment. If the employee claims exemption from income tax withholding, they must indicate this on their W-4. The amount of income tax withholding must be based on filing status and withholding allowances as indicated on the form. If a new employee does not give you a completed Form W-4, the IRS recommends that you withhold tax as if he or she is single, with no withholding allowances.
Withholding & Matching Taxes. So as an employer you will act as a collector and depositor of taxes. You should withhold the proper amount of federal income tax based on the employees Form W4. Additionally, you are required to withhold social security and Medicare taxes from your employees’ wages and pay the employer’s share of these taxes. Generally speaking the employee AND employer tax rate for social security is 6.2% on wages while the tax rate for Medicare is 1.45% each for the employee and employer (2.9% total). All of the above is deposited via a system called EFTPS by the employer.
Reporting. In addition to withholding and depositing payroll taxes, employers must periodically report these amounts to the government. These are done via Form 940, 941 or 944. You may be asking yourself “What is the difference between Federal 940, 941 and 944 taxes?” 941 tax filings are submitted each quarter. 944 tax is the same as the 941, but is filed and paid on an annual basis. The IRS makes the determination on which tax form you will file and how often you need to deposit your tax withholdings depending on the size of your payroll. 940 tax is Federal Unemployment. Unless you are exempt, you are required to report/pay this tax on an annual basis in addition to your 941 or 944 taxes.