Can sole proprietors have employees? Everything you need to know

What is a sole proprietorship?

A sole proprietorship is the simplest way to run a business because it’s you operating under your own name or a trade name. There is no separate legal entity. The profits flow to you, and the obligations do as well.

What is the main disadvantage of being a sole proprietor?

Personal liability is the big drawback because there’s no legal wall between the business and your personal life. If the business is sued or cannot pay a bill, your personal assets could be at risk, which is one of the reasons why many owners choose an LLC later to add a layer of protection. However, you can still hire employees as a sole proprietor today if that fits your stage.

Can a sole proprietor hire employees?

Yes. You can hire W-2 employees as a sole proprietor, and keep in mind that you can also use independent contractors for project work when needs arise. You do not need to form an LLC or a corporation first. Hiring does come with new responsibilities though — payroll, taxes, and insurance, to name a few. Think of it as adding a new lane to your business: things can move faster, but you’ll want to make sure the lines are painted clearly.

Now that we have a better understanding of the basics, let’s cover some steps to follow when you bring on a new team member.

How a sole proprietor can hire their first employee

Here’s a simple checklist to follow when you’re ready to bring someone on board.

1. Get an Employer Identification Number
   Apply for an EIN with the IRS; it’s free and quick, and you’ll use it on payroll tax forms and for state registrations.
2. Register with your state
   Open employer accounts with your state for income tax withholding and unemployment insurance. Every state has its own registration portal, so check your state’s requirements. Be sure to do this before your first payday.
3. Complete new hire forms
   Collect Form W-4 for federal withholding, plus be sure to complete Form I-9 and review the identity and work authorization documents. Many states also have their own state withholding forms, and you’ll want to keep these in a secure folder.
4. Report the new hire to your state
   Most states require a new hire report to be submitted within a short window after the start date. Payroll software often sends this information on your behalf, but it’s still a good idea to confirm that it has been filed correctly.
5. Get workers’ compensation insurance
   In almost all states, workers’ compensation is required once you have one or more employees. It covers medical bills and lost wages in the event of a worker’s injury or illness. Get the policy in place before day one.
6. Follow wage and hour laws
   Pay at least the applicable minimum wage, track hours, pay overtime when due for nonexempt roles, post required labor notices, and keep a safe workplace.
7. Set up payroll and a pay schedule
   Choose a consistent pay schedule, such as weekly, every other week, or twice a month, and stick with it. A trusted payroll system or service, like OnPay, will handle payroll for sole proprietors accurately, keeping calculations, deposits, and filings on time and organized. While doing payroll by hand may seem manageable at first, it often leads to mistakes and missed deadlines, so automation is the safer route.

How hiring employees affects a sole proprietor’s taxes

When you hire, you assume payroll tax responsibilities for each pay period. Here is what happens behind the scenes.

1. Calculate gross pay
   For hourly staff, hours times rate, plus overtime when required. For salary staff, annual salary divided by the number of pay periods.
2. Withhold employee taxes
   Withhold federal income tax and any state income tax based on the forms on file. Withhold the employee share of Social Security and Medicare.
3. Pay employer taxes
   Add your matching share of Social Security and Medicare. Pay federal unemployment and state unemployment. Some states have small additional payroll taxes.
4. Deposit and file
   Send withheld amounts and your employer taxes to the IRS and your state on the required schedule. File quarterly and annual payroll returns. At year end, issue Forms W-2 to employees.

Plan for these cash needs. Set aside payroll taxes so you never touch them. Many owners move the taxes into a separate savings account the same day they run payroll. Here’s another way to think about it: Out of sight, out of mind, never late.

Common pitfalls to avoid

After helping many owners with their first hire, I see the same mistakes. Avoid these and you will be ahead of the curve.

Misclassifying workers

If you control how, when, and where someone works, they are likely an employee and not a contractor. Calling a worker a contractor when they function like an employee can lead to back taxes and penalties. When in doubt, ask before you decide.

Skipping state registrations

Owners sometimes set up a payroll app and assume the rest happens on its own. It does not. You still need state withholding and unemployment accounts. Open them first, and you will not scramble later.

Forgetting workers’ compensation

If a worker gets hurt and you do not have the required policy, fines and out-of-pocket costs can follow. Start the policy before the first shift.

Forgetting the cost of employer taxes

Your employee sees net pay. You owe your share of taxes in addition. Budget for the full cost of each employee. A simple rule of thumb is to add a healthy percentage on top of wages to cover taxes and basic benefits.

Not using a payroll service

Trying to handle payroll on your own can quickly become overwhelming. A good payroll service automates tax calculations, filings, and deposits, reducing the chance of costly errors or late payments. It also keeps you compliant with changing tax rules and makes year-end forms like W-2s simple to generate. Using a reliable service saves time, protects you from penalties, and lets you focus on running your business instead of crunching numbers.

We’ve covered a lot of ground on the ins and outs of sole proprietorship — from hiring your first employee to handling payroll taxes. Now, let’s look at when it might make sense to change your business structure as your company grows.

When a sole proprietor should form an LLC or corporation:

There is no rule that says you must change your structure to hire. Still, growth brings new risks and goals. Consider moving to an LLC or a corporation when any of these are true.

• You face growing liability exposure.
• You are hiring multiple employees or plan to scale a team.
• You are signing larger contracts or working with bigger clients.
• You want the credibility of an entity name and a more formal structure.
• You are exploring tax strategies that work better with a different setup, such as an S corporation election.

An LLC can provide a liability shield when respected and run correctly. A corporation can make sense for some owners as well. The right choice depends on your industry, profit level, and growth plan. A short planning call can save you time and stress.