Hiring your first employee is a milestone. It also means your business takes on new responsibilities for employment taxes. This guide gives an overview of the federal pieces so you know what to expect and which IRS resources to rely on. State payroll requirements vary and are not covered here.
What "employment taxes" means
The IRS page Understanding employment taxes explains that employers must withhold federal income tax and the employee's share of Social Security and Medicare taxes, pay the employer's share of Social Security and Medicare taxes, and pay federal unemployment (FUTA) tax. Employers also deposit those taxes and file the related returns.
The main federal components
Federal income tax withholding
Employers generally withhold federal income tax from employees' wages. The IRS explains that the amount is figured using the employee's Form W-4 and the methods in Publication 15-T. Ask every new employee to complete Form W-4 when they start.
Social Security and Medicare taxes
Social Security and Medicare taxes are often called FICA taxes. Employers withhold part of these taxes from employee wages and pay a matching employer share. Rates and wage bases are set by law and can change, so use the current IRS publications rather than memorizing numbers.
Federal unemployment tax (FUTA)
FUTA tax is paid by the employer and is not withheld from employee wages. It works together with state unemployment programs. Your state may have its own unemployment tax account and filing requirements.
The employer's tax guide
The IRS Publication 15, Employer's Tax Guide, often called Circular E, is the primary federal reference for employers. It explains withholding, deposits, the returns employers file and the records to keep. It is updated regularly, so make sure you are reading the current version.
Depositing and filing
Withholding is only half the job. Employers must deposit the taxes they withhold and owe on a schedule, and file returns that report wages and taxes. Publication 15 explains how deposit schedules are determined and which returns apply. Late deposits and late filings can bring penalties, which is one reason many owners use a payroll provider or a payroll service.
Records to keep
The IRS asks employers to keep employment tax records for at least four years after the date the tax becomes due or is paid, whichever is later, as explained on How long should I keep records?. Keep W-4s, payroll registers, deposit confirmations and copies of returns together. Our article on how long to keep business records covers retention in more detail.
Employees versus contractors
Employment taxes apply to employees, not to independent contractors. Before you put someone on payroll or pay them as a contractor, make sure the classification is right. Our guide to employee vs. independent contractor explains how the IRS approaches the question.
A first-employee checklist
- Confirm the worker is an employee, not a contractor.
- Make sure your business has an Employer Identification Number (EIN).
- Have the employee complete Form W-4 and any state forms.
- Set up payroll, either in software or with a provider, using current withholding tables.
- Calendar deposit and filing deadlines.
- Record each payroll correctly in your books, separating gross wages, withholdings and employer taxes.
- Keep the records for at least the IRS retention period.
Keeping payroll and bookkeeping in sync
Payroll creates several entries in your books every pay period. When payroll and bookkeeping are handled separately, mismatches are common. Our payroll services are designed to work with our bookkeeping services so wages and payroll taxes are recorded correctly. Book a free consultation to talk about your first hire.
