Many people picture sole proprietorships as tiny, single-person businesses. The owner is tucked away in a little home office, working long, odd hours to keep their business going.
While this image might be true for some sole proprietorships, it’s certainly not true for all of them.
Businesses, hopefully, grow. As your sole proprietorship grows, you might realize you need help to keep up with all the tasks. So, you decide to hire an employee. But can you have employees as a sole proprietor? Or, do you need to change your business structure?
What is a sole proprietor?
First, let’s be clear about what is a sole proprietor.
A sole proprietorship is an unincorporated business that is owned by one person. You don’t have to declare your business as a sole proprietorship. When you start a business by yourself, it is automatically a sole proprietorship.
The owner is called a sole proprietor. If you own a sole proprietorship, there is no division between your personal and business assets. You are personally responsible for any business liabilities.
All your business income is reportable on your individual tax return. You will use Schedule C of Form 1040.
Can a sole proprietor hire employees?
A sole proprietor can hire employees. There is no limit to the number of workers you can employ.
As an employer, you are responsible for all employment administration, recordkeeping, and taxes. You have the same responsibilities as any other employer.
Before you hire employees, you need to get an employer identification number (EIN) from the IRS. Applying for an EIN is easy. You can instantly get one by applying on the IRS website. If you have time to wait, you can also apply by fax or mail.
Employees must fill out all necessary employment forms, including Form W-4 and Form I-9. You might also have the employee fill out forms to receive benefits.
After the employee begins working, you must withhold employment taxes from their wages. And, you must contribute employer taxes. Deposit the taxes and file payroll reports according to their schedules.
When you hire an employee, you do not become an employee. Your earnings are still subject to self-employment tax.
The wages you pay to employees are deductible as a business expense on your Form 1040 Schedule C. You can also deduct health care costs paid for an employee.
Hiring your spouse
As a sole proprietor, you can hire your spouse to be an employee. But, your spouse must be a legitimate employee. Don’t try to sneak around the IRS by adding your spouse as an employee when they aren’t doing the work of a legitimate employee.
If your spouse is your employee, their wages are not subject to federal unemployment tax (FUTA tax). However, their wages are still subject to federal income and FICA taxes. Be sure to check with your state to determine which state taxes to pay.
If you provide health benefits to your employees, your spouse can sign up for the benefits. You will be covered by your spouse’s plan. Also, the amount of the benefits are excluded from the spouse’s wages and are deductible from your Schedule C.
Other benefits that might be excluded from your spouse’s wages and are deductible from your taxes include group term life insurance, meals and lodging expenses, and transportation benefits.
Hiring your children
You can also hire your children to be your employees.
Even if you hire your own children, you must follow child labor laws.
Your tax liabilities might change, depending on the age of your child. You do not need to withhold or contribute FICA tax until the child is 18 years old. And, you do not need to pay FUTA tax until your child is 21 years old. You must always withhold federal income tax, no matter the child’s age. Check with your state to find out if you and your child are exempt from any state taxes.
Changing your business structure
You don’t need to change your business structure to hire employees. But even though you can have employees in a sole proprietorship, you might choose to change your business structure. For example, switching from sole proprietor to LLC will separate your business and personal assets and reduce your personal liability.
This separation will protect you personally if your business is sued or gets into any other trouble. Let’s say an employee gets hurt on the job and sues you. If you still operate a sole proprietorship, your personal assets might be at risk. But if you had switched to an LLC, your personal assets would be protected.
Use your own discretion to determine if your business should remain a sole proprietorship or if you should change business structures. An accountant or lawyer may be able to give you advice.
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This article is updated from its original publication date 4/25/2018.
This is not intended as legal advice; for more information, please click here.