A reader asked for advice on hiring her organization’s first employee. First let us say congratulations for reaching this milestone!
Your first employee, while exciting, also opens up a whole new world of responsibilities, risk management and administration. What are the critical steps? Where do you begin? We offer a punch list of things you should know and do when you hire an employee.
1. Understand the definition of employee vs. contractor.
A great place to begin is making sure you understand who should be classified as an employee. People who perform services for your organization fall into one of two main categories:
- Independent contractors
It’s important to properly classify a worker because the compensation and tax rules are different for each category. Per the IRS, if the employer has the “right to direct and control the work performed by the worker,” that person is an employee. See the IRS fact sheet, Understanding Employee vs. Contractor Designation. Also see our earlier post, 1099-MISC in a Nutshell for information on contractor reporting requirements.
In this post we are focused on employees.
2. Understand payroll taxes.
Federal Payroll Taxes
You are required to collect and remit payroll taxes to the United States Treasury:
- Social Security – Employees pay 6.2% of calendar year gross wages up to the wage base ($128,400 for 2018). The employer pays a matching amount.
- Medicare – Employees pay 1.45% of gross wages. The employer pays a matching amount.
- Additional Medicare – Employees pay 0.9% of calendar year wages in excess of $200,000.
For-profit employers must also pay Federal unemployment tax. 501(c)(3) nonprofit organizations are EXEMPT from Federal unemployment tax and do not need to file the related Form 940 return.
State and Local Payroll Taxes
State and local payroll taxes depend on the requirements for your area. We are in Florida so we will describe the Florida requirements.
Florida requires nonprofit organizations to pay state unemployment tax (renamed “reemployment tax”) if they employ four or more employees. If you are a new employer with up to three employees, you will not need to register for or pay this tax. (See Florida Information for Nonprofit Organizations.)
Florida does not have state income tax. Other areas of the country may require withholding of state and local payroll taxes from employee wages.
Remitting Payroll Taxes
If you use an outside payroll service, they will withdraw payroll taxes electronically from your bank account shortly after you submit each payroll and remit them accordingly. If you decide to handle payroll yourself (see #5 for our advice below) refer to IRS Publication 15 (Circular E), Employer’s Tax Guide for details on when and how you must remit Federal payroll taxes. Refer to state and local governments for the requirements in your area.
Filing Payroll Tax Returns
501(c)(3) nonprofit employers must file:
- Form 941 with the IRS quarterly to report wages paid, employer and employee payroll taxes, and tax paid during the preceding quarter
- State and local payroll tax returns, if applicable
- Annual Forms W-2 to the Social Security Administration with a copy to the employee
3. Decide whether your employee is hourly or salaried and set a payroll schedule.
The Fair Labor Standards Act (FLSA) sets the minimum wage for hourly (nonexempt) employees, currently $7.25 per hour. Your state may have a higher minimum wage, such as the current $8.25 in Florida. The FLSA also sets the requirements for overtime pay for hourly employees.
The FLSA also defines the nature of the work performed by salaried (exempt) employees (executive, administrative or professional job duties) and the minimum salary ($455 per week). See this FLSA Fact Sheet for more information.
Pay periods are typically weekly, every other week, twice per month or monthly. Salaried employees are often paid on the last day of the pay period. After all, there is no calculation to be done. A salary is the same amount each pay period until the annual salary amount is changed. Hourly employees are often paid about a week after the end of the pay period to allow time for time sheets to be submitted, approved, and entered into the payroll system.
Also keep in mind that after you submit employee hours to be paid, it takes time for direct deposit payroll to be processed. Some payroll services can deposit net paychecks into employee bank accounts as quickly as the day after it is submitted. Other payroll services require as long as four days. To give yourself some breathing room, we suggest making pay day a week after the end of the pay period.
4. Know worker’s compensation insurance requirements.
State laws also govern workers’ compensation insurance. In Florida, non-construction employers are not required to obtain workers’ compensation insurance until they have four or more employees.
5. Decide between “do it yourself” and full service payroll.
We get it – cash is tight, and you feel pressure to spend as much as possible on programs while minimizing administration costs. (Check out our series of posts on nonprofit overhead.)
But resist the temptation to “do it yourself” when it comes to payroll. Payroll has more complexity than you think, it’s nitpicky as to calculations and dates, and it’s a ball that can never be dropped.
Recently we helped an organization where a volunteer handled payroll for several employees. Nobody had told the volunteer about filing payroll tax returns, so for over a year no returns were filed with the IRS. Nobody explained how to use QuickBooks desktop software to calculate and remit payroll taxes, so the books had multiple errors. Plus the payroll software was on a laptop computer kept by the volunteer. No one could easily access it if necessary as a backup for running payroll, paying payroll taxes, or filing payroll tax returns.
The solution? After helping the organization file the late payroll tax returns and fixing their books, we transitioned payroll to a full service payroll provider. Now the volunteer or a backup person can login from anywhere to run payroll. The payroll company will remit payroll taxes and file all payroll tax returns.
We hasten to add – even if you hire a full service payroll company, the ultimate responsibility for paying payroll taxes and filing payroll tax returns remains with the organization. It’s a good idea to be familiar with your basic responsibilities as an employer so you know if the service you hired is doing what they are supposed to do. A good reference is IRS Publication 15 (Circular E), Employer’s Tax Guide.
Whether you decide to do it yourself or go with a payroll service, we suggest noting due dates for payroll taxes, payroll tax returns, and running payroll in your calendar. We offer a Compliance Task Checklist in our Free Member Resource Library to help you keep up with these and other tasks of running an organization.
6. Decide how you will enter payroll transactions into your books.
The software used to process your payroll (whether it’s “do it yourself” software or a payroll service’s software) is separate from the accounting software you use for bookkeeping. (We do not recommend doing payroll without payroll software. It’s possible, but much harder and more error-prone.) Look for payroll software that can integrate with or import transactions into your accounting software and that can satisfy the level of reporting you need. See our blog post Select the Right Accounting Software for Payroll and Contractors.
7. Create an employee manual.
We have seen clients run into trouble when they did not clearly define employee policies and procedures. An employee manual can cover topics like overtime, sick/vacation days, health insurance, work-at-home options, organization culture, employee loan policies, performance reviews, and more. Here’s an overview by Inc., What to Include In an Employee Handbook. We encourage you to check with an attorney or a human resources specialist for more guidance.
8. Document travel policies and procedures.
Once you have an employee, the topic of travel reimbursement may arise. For example, if the employee runs an errand to the office supply store using her own car, what is your policy for mileage reimbursement? If you search online for “travel policies and procedures” you will find many examples. The extensiveness of your travel policies and procedures will depend on your organization’s needs.
9. Hire your employee.
Once you have covered the above areas, you are ready to hire your first employee. The following are “must do’s”:
- Have the employee complete Form W-4 to determine income tax withholding.
- Employer and employee complete Form I-9 to verify the employee’s identity and eligibility to work in the United States
See this short IRS article, Hiring Employees.
Here are other things to consider:
- Have the employee complete an employment application.
- Execute an employee agreement.
- Run a background check – especially if the employee will be handling money or will be in a position to interact with vulnerable clients.
- Have the employee fill out and sign a Direct Deposit Authorization form giving permission to pay by direct deposit to the employee’s bank account instead of by physical check.
If your organization is in Florida, report your new hire to the State of Florida.
10. Buy a cake and celebrate.
Your organization just grew by its first employee! Time to celebrate!