Can sole proprietors have employees? Yes, here’s how to do it

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. There’s no separate legal entity, so the profits and the obligations both flow directly to you.

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 someone sues the business or the business can’t pay its debts, you risk losing your personal assets. That risk is one reason many owners eventually form an LLC for added protection. However, you can hire employees as a sole proprietor right now without waiting to change your business structure.

Can a sole proprietor hire employees?

Yes, and there’s no legal limit on how many employees you can hire. You can bring on W-2 employees or work with independent contractors for project-based work, and you don’t need to form an LLC or a corporation first. Hiring does come with new responsibilities, though, including 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 understand 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 before your first payday.
3. Complete new hire forms
   Collect Form W-4 for federal withholding. You also need to collect a completed Form I-9 and review their identity and work authorization documents. Many states have their own state withholding forms. Keep all of these in a secure place.
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
   Nearly all states require workers’ compensation once you have one or more employees. It covers medical bills and lost wages if a worker is injured or becomes ill on the job, so get the policy in place before day one. Some states make an exception if the only other worker in your business is your spouse and they’re a co-owner. Check with an insurance agent who’s familiar with your state’s requirements.
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, keeps your calculations, deposits, and filings accurate and on time. Doing payroll by hand may seem manageable at first, but 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, take on payroll tax responsibilities for each pay period. Here’s what happens behind the scenes.

1. Calculate gross pay
   For hourly staff, it’s hours times rate, plus overtime when required. For salaried staff, it’s their 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, along with the employee share of Social Security and Medicare.
3. Pay employer taxes
   Add your matching share of Social Security and Medicare, plus federal and state unemployment tax. Some states also 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.

ahead for these cash needs. Set aside payroll taxes so you’re not tempted to touch them. Many owners move the taxes into a separate savings account the same day they run payroll. 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 come up again and again. Avoid these, and you’ll be ahead of the curve.

Misclassifying workers

If you control how, when, and where someone works, they’re an employee, 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 automatically. It doesn’t. You still need state withholding and unemployment accounts, so open them first, and you won’t be scrambling later.

Forgetting workers’ compensation

If a worker gets hurt and don’t 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

Budget for the full cost of each employee before you hire, not just their wage or salary. According to the U.S. Small Business Administration, a good rule of thumb is to plan for 1.25 to 1.4 times their salary to cover employer-side payroll taxes and benefits.

Not using a payroll service

Handling 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 proprietorships, 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:

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

• You face growing liability exposure.
• Youplan to hire multiple employees or scale a team.
• You’re signing larger contracts or working with bigger clients.
• You want the credibility of a more formal business structure.
• You’re exploring tax strategies that work better with a different setup, such as an S corporation election.

An LLC can provide a liability shield when handled correctly, and yes, an LLC can hire W-2 employees, too. The hiring steps are largely the same: get an EIN, register with your state, and set up payroll and workers’ comp insurance on day one.

A corporation makes sense for some business owners as well. The right choice depends on your industry, profit level, and growth plan. A short planning call with your accountant and attorney can save you time and stress.