Legal Requirements for Hiring Employees: Complete Guide for Small Business Owners

1. Obtain an Employer Identification Number (EIN)

Your first step in hiring employees is obtaining an Employer Identification Number (EIN) from the IRS. This nine-digit number is essential for tax filing and reporting purposes—think of it as a Social Security number for your business. All businesses that hire employees must have an EIN, regardless of whether you’re a sole proprietorship, partnership, or registered corporation.

To get your EIN, file Form SS-4 with the IRS online. The person applying (called the responsible party) must have a valid taxpayer identification number, such as a Social Security number. Complete your application in one session—if you’re inactive for more than 15 minutes, your session will expire and you’ll need to start over. While online applications are fastest, you can also fax or mail your application, though this will increase processing time. You can also hire services like CorpNet to obtain your EIN for you, saving time and effort.

2. Register for Payroll Taxes

Payroll taxes are federal and state taxes you’re legally required to deposit and report on behalf of your employees. These employment taxes include withholding from employees’ paychecks for federal, state, and local income taxes. You’re also responsible for both the employee and employer shares of Social Security and Medicare taxes (FICA taxes), as well as federal unemployment taxes (FUTA).

Many states also collect State Unemployment Tax Act (SUTA) taxes. If you pay both FUTA and SUTA taxes, you may qualify for a discount on federal taxes.

Your Payroll Responsibilities Include:

Calculating tax withholding correctly. The amount withheld depends on information from the employee’s W-4 form, their salary, and deductions. For example, if an employee earns $45,000 annually and indicates a 10% tax bracket, you would withhold approximately $4,500 per year from their paychecks.

Making timely deposits. Federal tax deposits must be made by electronic funds transfer at scheduled intervals based on your business size and withholding amounts.

Filing quarterly (or annual) reports. You must submit employment tax reports including income tax and FICA withheld, using Form 941 for quarterly reporting.

Additional reporting as required. This includes state and local tax filings and annual federal reports like Form W-2 (sent to employees) and Form W-3 (transmittal to Social Security Administration).

All employers must file Form 940 (annual FUTA tax return) and Form 941 (quarterly employer tax return). Failing to properly handle payroll taxes can result in penalties, interest, and even criminal prosecution. If you’re unsure about managing payroll taxes, consider hiring a tax professional or payroll service company.

3. Obtain a State Tax ID Number

If your state has income tax, you’ll need a state tax identification number. Seven states (Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming) have no income tax, and two states (Tennessee and New Hampshire) only tax dividend and interest income. All other states require businesses to register for income tax and possibly employment taxes. The process varies by state, so consult your state’s tax authority, or work with an accountant or attorney to determine your requirements.

4. Review Your Company’s Nexus Status in Other States

If your company has connections to another state, you may be responsible for collecting and paying taxes there. Nexus is the connection your business has to a state that creates tax obligations. A business has nexus with another state if:

• It has a physical presence like a store, office, or warehouse there
• It has economic activity or income in the state without physical presence
• It has employees working there

If you have nexus in multiple states, you’ll need to register for payroll in each state and likely apply for foreign qualification—the process of getting permission to do business in a state other than where your company is registered. This requires registering with the Office of the Secretary of State or comparable agency in that state. Understanding nexus is complex because definitions and rules vary significantly from state to state and change frequently, so stay informed about current requirements.

5. Determine If You’re Hiring an Employee or a Contractor

Proper classification is critical for tax purposes. Employees require you to withhold and deposit income taxes, Social Security taxes, Medicare taxes, and federal and state unemployment taxes. With independent contractors, you generally don’t withhold or pay taxes—they handle their own tax obligations. Misclassifying a worker can result in significant penalties and back taxes. Carefully evaluate whether your hire qualifies as an employee or independent contractor based on factors like control, independence, and the nature of the working relationship.

6. Schedule Your Pay Periods

You can pay employees weekly, biweekly, semi-monthly, or monthly. Biweekly is most common, but your choice depends on your business’s cash flow and needs. However, states have minimum pay frequency requirements for employees, so check with your state’s Department of Labor to ensure you’re compliant. Consistency and clear communication about pay schedules are important for employee satisfaction and legal compliance.

7. Select a Payroll System and Payroll Manager

You have two options: hire a payroll service company or manage payroll yourself using software. Many popular payroll processing companies like Gusto, Paychex, and Onpay offer SaaS-based solutions starting as low as $16 per month, scaling based on employee count and payroll frequency. These services automate entries, file necessary tax forms, and help ensure compliance. Before managing payroll in-house, consider your available time and anticipated company growth, which could complicate self-management.

8. Create a Formal Policy for Holiday, Vacation, and Leave

Clarify what compensation employees receive for holidays, vacation, and family and medical leave. While no federal law currently requires this compensation, many states and municipalities have enacted requirements. Research your legal obligations and decide on a compensation mix that both complies with law and helps you attract and retain qualified talent. A clear written policy prevents misunderstandings and disputes.

9. Comply With All Form and Identification Requirements

New employees must complete a W-4 form, which provides information needed to calculate federal income tax withholding. They must also complete an I-9 form to verify eligibility to work in the United States. Additionally, you must report new hires to your state within 20 days of hiring, providing full names, contact information, and Social Security numbers. This information goes into the National Directory of New Hires, used to locate individuals who owe child support and for wage withholding purposes.

Verify the employee’s name and Social Security number through the Social Security Administration’s website to ensure accuracy in your records and tax reporting.

10. Know What You Can and Cannot Ask Employees

During interviews, it’s fine to ask about prior work experience and qualifications for the position. However, the Equal Employment Opportunity Commission recommends avoiding questions about protected characteristics including race, color, religion, sex, national origin, and age. These questions could expose you to discrimination claims. Focus interviews on job-related qualifications and experience.

11. Consider Optional Employee Benefits

Group health plans and retirement plans are attractive to employees. Given a choice, most employees prefer companies offering these benefits. While you may not afford benefits when starting out, they become increasingly important as your business grows and you compete for talent. Benefits significantly impact employee retention and satisfaction.

12. Consider Employee Incentive Programs

Beyond traditional benefits, incentive programs like stock options, flexible time, company events, wellness programs, and corporate memberships boost morale and make hiring easier as your company grows. Choose incentives that fit your budget while reflecting your company values and culture.

13. Create an Employee Handbook

Every company has its own culture, and new employees should understand expectations and company norms. A well-developed employee handbook communicates your company culture, rules, legal employee rights, policies, and processes. It puts everyone on the same page and serves as a reference for resolving questions or disputes.

14. Adhere to Federal and State Employee Notice Requirements

Employers with annual sales above $500,000 or those with federal contracts must comply with the Fair Labor Standards Act (FLSA), a federal law protecting workers against unfair pay practices. The FLSA sets minimum wage requirements, specifies overtime pay rules, and restricts child labor. If the FLSA applies to your company, you may be required to display a poster explaining these rules. Additionally, check with your state’s Department of Labor for any state-specific poster requirements.

15. Comply With OSHA Rules

All employers must comply with federal Occupational Safety and Health Administration (OSHA) rules designed to protect workers. These regulations require protecting workers from harmful substances like asbestos, preventing infectious diseases, providing necessary safety equipment, and offering training for dangerous jobs. If applicable, your workplace must display signs, labels, and codes warning employees of potential hazards.

Final Thoughts

Hiring employees involves navigating substantial legal and regulatory requirements. Pay particular attention to payroll taxes—understand which taxes apply to you, when they’re due, how much to withhold, and all related obligations. Think long-term when building your team, focusing on creating a strong workforce that helps your company grow and prosper.

The regulations surrounding employee hiring are complex and subject to change. If you’re uncertain about requirements that apply to your specific situation, consult with an attorney or tax advisor to ensure full compliance. Taking time to get these fundamentals right from the start protects your business, creates a compliant workplace, and sets the foundation for sustainable growth.