Yes, a sole proprietor can have employees. Nothing in federal tax law limits hiring to corporations or LLCs, and plenty of sole proprietorships run with full-time, part-time, or seasonal staff. What changes the day you bring on your first worker is your status: you go from a self-employed individual to an employer, and a stack of federal and state obligations attaches to you personally. Getting the pieces lined up before that first paycheck is the whole game, because there is no corporate entity between you and the penalties if something slips.
You Still Can’t Put Yourself on Payroll
One boundary worth clearing up first. Hiring employees does not let you pay yourself a wage. The IRS treats you and your sole proprietorship as the same tax entity, so your income still flows through Schedule C on your personal Form 1040, and you still pay self-employment tax on the net profit rather than having payroll taxes withheld.1Internal Revenue Service. Schedule C (Form 1040) – Profit or Loss From Business (Sole Proprietorship) Money you take out of the business is a draw. The employees you hire are treated completely differently: W-2s, withholding, the works.
What You Need Before the First Paycheck
An Employer Identification Number
Before hiring, most sole proprietors do everything under a Social Security Number. Once you pay wages, you need a separate nine-digit EIN for employer tax filings and deposits.2Internal Revenue Service. About Form SS-4, Application for Employer Identification Number (EIN) The IRS online application issues the number immediately, takes about 15 minutes, and costs nothing.3Internal Revenue Service. Get an Employer Identification Number Fax or mail through Form SS-4 works too, just slower.
State Payroll Accounts
Federal registration is only half of it. You also need accounts with your state’s revenue department for income tax withholding and your state’s labor or workforce agency for unemployment insurance. Some states run a single online portal; others need separate applications. A handful require registration for state disability insurance or paid family and medical leave, and more than a dozen states plus the District of Columbia operate mandatory paid family leave programs as of 2026, with more starting in mid-2026. City income tax withholding can add another layer. Check your state’s department of revenue and department of labor before the first payday so you know exactly what accounts to open.
Classify the Worker Correctly
W-2 employee or 1099 contractor? The distinction drives everything that follows. You owe payroll taxes, wage-and-hour protections, and insurance only for W-2 employees. Misclassifying an employee as a contractor exposes you to back taxes, penalties, and liability from both the IRS and state labor agencies.
The IRS looks at three categories of evidence: behavioral control (do you direct what the worker does and how), financial control (can the worker profit or lose money independently and supply their own tools), and the type of relationship (benefits, written contract, expected duration).4Internal Revenue Service. Independent Contractor (Self-Employed) or Employee No single factor decides the question. The Department of Labor uses a related test focused on whether the worker is economically dependent on you or genuinely running their own business, weighing your degree of control and the worker’s real opportunity for profit or loss. When in doubt, treat the worker as an employee. Compliance costs less than a misclassification audit.
The Onboarding Paperwork
Three items need to be handled at or near the start date for each W-2 hire:
- Form I-9. The employee completes their section on or before day one, and you examine the supporting documents and complete your section within three business days. Keep the form for at least three years after hire or one year after employment ends, whichever is later.5U.S. Department of Labor. I-9 Central
- Form W-4. The employee fills this out so you can calculate federal income tax withholding. Keep it on file; don’t send it to the IRS unless asked.6Internal Revenue Service. About Form W-4, Employee’s Withholding Certificate
- New hire report. Report basic information (name, address, Social Security Number, your EIN) to your state’s designated agency within 20 days of hire. Some states use shorter deadlines.7Administration for Children and Families. New Hire Reporting
E-Verify is voluntary for most private employers under federal rules, but some states require it as a condition of doing business.8E-Verify. Background and Overview Confirm your state’s rule before assuming you can skip it.
Payroll Taxes You’ll Owe Every Pay Period
FICA
Social Security tax is 6.2% of gross wages from the employee and a matching 6.2% from you, up to the 2026 wage base of $184,500 per employee.9Social Security Administration. Contribution and Benefit Base Medicare is 1.45% each side with no cap.10Internal Revenue Service. Topic No. 751, Social Security and Medicare Withholding Rates Combined, each side pays 7.65%, so total FICA on every dollar of wages up to the Social Security cap is 15.3%.
An extra 0.9% Additional Medicare Tax applies to any single employee’s wages above $200,000 in a calendar year. There’s no employer match on that piece; it all comes out of the employee’s wages.11Internal Revenue Service. Questions and Answers for the Additional Medicare Tax
Federal Income Tax Withholding
Withholding is calculated from the W-4 using the tables in IRS Publication 15 (Circular E).12Internal Revenue Service. Publication 15, (Circular E), Employer’s Tax Guide Unlike the flat FICA percentage, withholding varies by filing status, dependents, and any additional amounts the employee requests.
Depositing the Taxes
Federal payroll deposits run through the Electronic Federal Tax Payment System (EFTPS).13Internal Revenue Service. EFTPS: The Electronic Federal Tax Payment System The IRS puts you on either a monthly or semiweekly schedule based on the total tax you reported during a lookback period. At $50,000 or less, monthly; above that, semiweekly.14Internal Revenue Service. Notice 931 – Deposit Requirements for Employment Taxes Brand-new employers usually start as monthly depositors. If your total quarterly liability is under $2,500, you can pay with the quarterly return instead of making separate deposits.12Internal Revenue Service. Publication 15, (Circular E), Employer’s Tax Guide
FUTA and State Unemployment
Federal Unemployment Tax (FUTA) applies to the first $7,000 of each employee’s annual wages. The statutory rate is 6.0%, but employers in states with qualifying unemployment programs get a credit of up to 5.4%, dropping the effective rate to 0.6% in most cases.15Internal Revenue Service. Topic No. 759, Form 940 – Filing and Deposit Requirements At the reduced rate, that’s a maximum of $42 per employee per year. FUTA is entirely on you; nothing comes from the employee’s pay.
A few states with outstanding federal unemployment loans face a FUTA credit reduction that raises the effective rate. The IRS publishes the affected list each year.16Internal Revenue Service. FUTA Credit Reduction If your FUTA liability exceeds $500 in a quarter, deposit it by the end of the following month; otherwise carry it forward to the Form 940 filing.
State unemployment insurance is separate and funded through employer contributions. New employers pay a standard starter rate that adjusts over time based on claims history. Rates range from under 1% to over 10%, and the taxable wage base varies widely by state, from $7,000 in some to well over $40,000 in others.
The Reporting Calendar
Hiring locks you into a recurring filing cycle. Missing deadlines triggers penalties that compound fast.
- Form 941, quarterly. Due by the last day of the month following each quarter. Reconciles FICA and income tax withholding for the quarter against what you deposited.17Internal Revenue Service. Form 941 – Employer’s Quarterly Federal Tax Return
- Form 944, annual alternative. If your total annual employment tax is $1,000 or less, you may qualify to file once a year instead of quarterly. You need IRS notification or approval to use it.18Internal Revenue Service. Instructions for Form 944
- Form 940, annual. Reports FUTA liability. Due January 31 of the following year, or February 10 if you deposited all FUTA taxes on time.15Internal Revenue Service. Topic No. 759, Form 940 – Filing and Deposit Requirements
- Form W-2, annual. Furnish to each employee and file with the Social Security Administration by February 1 of the following year. For the 2026 tax year, that deadline is February 1, 2027.19Internal Revenue Service. General Instructions for Forms W-2 and W-3
Most states layer on their own quarterly wage reports and unemployment filings. Deadlines usually mirror the federal schedule, though a few states require more frequent withholding deposits.
Wage, Hour, and Insurance Rules
Once you have employees, the Fair Labor Standards Act applies regardless of business size. The federal minimum wage is $7.25 per hour, unchanged since 2009. Many states and cities are higher, and you pay whichever is greater. Overtime kicks in for any non-exempt employee working more than 40 hours in a workweek, at 1.5 times the regular rate.20U.S. Department of Labor. Overtime Pay You cannot average across two weeks even if you pay biweekly. Each workweek stands alone.
Workers’ compensation is required in the vast majority of states. It pays medical costs and part of lost wages for on-the-job injuries, and in return the employee generally cannot sue you for those injuries. Coverage usually comes from a private insurer, though some states run their own fund. Premiums depend on the type of work and total payroll. Whether you as the sole proprietor must be on the policy depends on state rules.
Several states run mandatory short-term disability programs, including California, New York, New Jersey, Hawaii, and Rhode Island. Mandatory paid family and medical leave is expanding across additional jurisdictions. Where these programs exist, you’ll register separately, contribute on a regular schedule, and show the deductions on pay stubs.
Why the Stakes Are Higher for a Sole Proprietor
This is where a sole proprietorship diverges sharply from a corporation. When a corporation misses payroll tax deposits, the IRS pursues the entity first. When a sole proprietor misses, the IRS comes directly after you, because you and the business are the same legal person. There’s no corporate shield.
Trust Fund Recovery Penalty
The income tax you withhold and the employee’s share of FICA are held in trust for the government. Use those funds for rent, suppliers, or other bills instead of depositing them, and the IRS can assess the Trust Fund Recovery Penalty against you personally: 100% of the unpaid trust fund taxes, plus interest.21Internal Revenue Service. Trust Fund Recovery Penalty The IRS treats spending withheld taxes on other expenses as a willful act. On tight margins, this is the single most dangerous compliance failure.
Late Deposit Penalties
Even honest lateness costs. The IRS applies a tiered penalty:
- 1 to 5 days late: 2% of the unpaid amount
- 6 to 15 days late: 5%
- More than 15 days late: 10%
- More than 10 days after an IRS notice demanding payment: 15%
Tiers don’t stack. If you’re more than 15 days late, you pay 10%, not a combined total.22Internal Revenue Service. Failure to Deposit Penalty
Personal Liability Beyond Taxes
Tax exposure is only part of the picture. Because a sole proprietorship offers no separation between you and the business, employee-related lawsuits reach your personal bank accounts, home equity, and other assets. If an employee injures a customer on the job, or if you face a wage-and-hour complaint, the claim runs to you personally. Workers’ compensation covers workplace injuries but doesn’t insulate you from every employee-related claim. Many sole proprietors who reach the point of having multiple employees eventually restructure as an LLC or corporation for that reason.