Yes, a sole proprietor can have employees. Nothing in the structure of a sole proprietorship prevents you from hiring full-time, part-time, or seasonal workers, but the moment you put someone on payroll you become an employer with a full set of federal and state obligations: a new tax ID, payroll tax accounts, insurance coverage, wage-and-hour compliance, and recurring filings. And because a sole proprietorship provides no legal separation between you and the business, every one of those obligations lands on you personally.
One boundary worth clearing up before anything else: you are not your own employee. The IRS treats you and your business as the same tax entity, so you cannot put yourself on payroll. Your business income flows through Schedule C of your Form 1040, and you pay self-employment tax on the net profit.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 people you hire are different: they get W-2s, have taxes withheld, and trigger everything below.
Get an EIN Before the First Paycheck
Your first concrete step is getting an Employer Identification Number from the IRS. Before hiring, most sole proprietors run everything under a Social Security Number. Once you pay wages, you need a separate nine-digit EIN for all employer tax filings and deposits.2Internal Revenue Service. About Form SS-4, Application for Employer Identification Number (EIN)
The IRS online application issues the EIN immediately. It takes about 15 minutes, costs nothing, and produces a confirmation notice you can print at the end.3Internal Revenue Service. Get an Employer Identification Number You can also apply by fax or mail with Form SS-4, but online is the practical choice for any U.S.-based business.
Register With Your State
Federal registration is only half the picture. You also need accounts with your state’s revenue department for income tax withholding and with your state labor or workforce agency for unemployment insurance contributions. These accounts give you the state ID numbers you’ll use when you remit withheld tax and unemployment premiums.
The specifics vary. Some states run a single online portal that handles everything; others require separate applications for each agency. A handful require registration for state disability insurance or paid family and medical leave. As of 2026, more than a dozen states and the District of Columbia operate mandatory paid family leave programs that require employer contributions, with several more beginning collections in mid-2026. Local jurisdictions can add city income tax withholding or occupational licensing fees. Check with your state’s department of revenue and department of labor before your first payday so you know which accounts you actually need.
Employee or Independent Contractor?
Before you hire anyone, decide whether the person is a W-2 employee or a 1099 independent contractor. 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 weighs three categories of evidence: behavioral control (whether you direct what the worker does and how), financial control (whether the worker can profit or lose money independently and provides their own tools), and the type of relationship (benefits, written contract, expectation of an ongoing arrangement).4Internal Revenue Service. Independent Contractor (Self-Employed) or Employee No single factor decides it.
The Department of Labor uses a related but distinct test when enforcing wage and hour laws, centered on whether the worker is economically dependent on you or genuinely operating their own business. The two factors it weighs most heavily are the degree of control you exercise and whether the worker has a real opportunity for profit or loss based on their own initiative and investment. If you set the schedule, supply the equipment, and the worker has no way to earn more through their own business judgment, that person is almost certainly an employee under federal law.
When you can’t tell, treat the worker as an employee. Compliance costs less than a misclassification audit.
Paperwork for Each New Hire
Once you’ve decided a worker is a W-2 employee, three pieces of federal paperwork need to be completed before or shortly after the first day.
Form I-9. Federal law requires every employer to verify each new hire’s identity and work authorization. The employee completes their section on or before the first day, and you must examine the supporting documents and complete your section within three business days of the hire date. Keep the form for at least three years after the hire date 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 the correct federal income tax withholding. You don’t send it to the IRS unless specifically asked; keep it on file.6Internal Revenue Service. About Form W-4, Employee’s Withholding Certificate
New hire reporting. Federal law requires you to report basic information about each new employee to your state’s designated agency within 20 days of the hire date. Some states impose shorter deadlines. The report includes the employee’s name, address, Social Security Number, and your EIN.7Administration for Children and Families. New Hire Reporting
E-Verify, the federal electronic work authorization system, is voluntary for most private employers at the federal level. Employers with federal contracts that include the E-Verify clause must use it, and a growing number of states require it as a condition of business licensing.8E-Verify. Background and Overview Check your state’s rules before assuming you can skip it.
Payroll Taxes You’ll Owe
Every time you cut a paycheck, you owe federal payroll taxes in two categories: FICA (Social Security and Medicare) and federal income tax withholding.
FICA
Social Security tax is 6.2% of gross wages, with a matching 6.2% from you as the employer, applied to wages up to the 2026 wage base of $184,500 per employee.9Social Security Administration. Contribution and Benefit Base Medicare tax is 1.45% on each side with no wage cap.10Internal Revenue Service. Topic No. 751, Social Security and Medicare Withholding Rates Combined FICA is 7.65% per side, for a total of 15.3% on every dollar of wages up to the Social Security cap. For any employee whose wages from you exceed $200,000 in a calendar year, you also withhold an Additional Medicare Tax of 0.9% on the excess, with no employer match.11Internal Revenue Service. Questions and Answers for the Additional Medicare Tax
Federal Income Tax Withholding
You calculate federal income tax withholding from the employee’s Form W-4 using the tables in IRS Publication 15 (Circular E).12Internal Revenue Service. Publication 15, (Circular E), Employer’s Tax Guide Unlike FICA, this amount varies by employee based on filing status, dependents, and any additional withholding they request.
FUTA
On top of FICA, you owe Federal Unemployment Tax on 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%, bringing the effective rate to 0.6% in most cases, or about $42 per employee per year at the reduced rate.13Internal Revenue Service. Topic No. 759, Form 940 – Filing and Deposit Requirements FUTA is entirely on you; nothing comes out of the employee’s paycheck. A few states with outstanding federal unemployment loans face a FUTA credit reduction that raises the effective rate. The IRS publishes the list each year.14Internal Revenue Service. FUTA Credit Reduction
Depositing the Taxes
All federal payroll tax deposits go through the Electronic Federal Tax Payment System.15Internal Revenue Service. EFTPS: The Electronic Federal Tax Payment System The IRS assigns you either a monthly or semiweekly deposit schedule based on the total tax liability you reported during a lookback period: $50,000 or less means monthly, above $50,000 means semiweekly.16Internal Revenue Service. Notice 931 – Deposit Requirements for Employment Taxes Brand-new employers with no filing history are generally monthly depositors. If your total quarterly tax liability is under $2,500, you can pay with your quarterly return instead of making separate deposits.12Internal Revenue Service. Publication 15, (Circular E), Employer’s Tax Guide FUTA deposits are quarterly whenever accumulated liability exceeds $500; below that, you can carry it forward.
Recurring Filings
Hiring employees locks you into a reporting cycle. Missing these deadlines produces penalties that compound quickly.
- Form 941, due the last day of the month after each calendar quarter, reconciles the FICA and income tax withholding you owed with the deposits you made.17Internal Revenue Service. Form 941 – Employer’s Quarterly Federal Tax Return
- Form 944 is an annual alternative if your total annual employment tax liability is $1,000 or less. You need IRS notification or approval to use it.18Internal Revenue Service. Instructions for Form 944
- Form 940 reports your annual FUTA liability. Due January 31, or February 10 if you deposited all FUTA on time.13Internal Revenue Service. Topic No. 759, Form 940 – Filing and Deposit Requirements
- Form W-2 goes to each employee, with copies to the Social Security Administration, by February 1 of the following year. For the 2026 tax year, the deadline is February 1, 2027.19Internal Revenue Service. General Instructions for Forms W-2 and W-3
Most states also require their own quarterly wage reports and unemployment insurance filings, with deadlines that generally mirror the federal schedule.
Wage and Hour Rules
Hiring employees puts you under the Fair Labor Standards Act. The federal minimum wage is $7.25 per hour, unchanged since 2009. Many states and cities set higher minimums; when they differ, you pay whichever is higher. Overtime pay of at least 1.5 times the regular rate applies to any non-exempt employee who works more than 40 hours in a single workweek.20U.S. Department of Labor. Overtime Pay You cannot average hours across two weeks to avoid overtime, even on a biweekly pay cycle. Each workweek stands alone.
If you’re thinking about younger workers, the FLSA sets 14 as the minimum age for most non-agricultural employment. Workers under 16 face limits on hours and tasks, and anyone under 18 is generally barred from hazardous occupations.21U.S. Department of Labor. Age Requirements State child labor laws sometimes go further, and the stricter rule applies.
State Unemployment, Workers’ Comp, and Other State Programs
Every state runs its own unemployment insurance program 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% of a state-defined taxable wage base, and the wage base itself ranges from as low as $7,000 in some states to well over $40,000 in others.
The vast majority of states also require workers’ compensation coverage. This insurance pays medical costs and a portion of lost wages when an employee is injured on the job, and in exchange the employee generally cannot sue you for workplace injuries. You typically buy a policy from a private insurer, though some states run their own fund. Premiums depend on the type of work your employees do and your total payroll. Whether you as the sole proprietor must be included in the policy depends on state rules.
Several states, including California, New York, New Jersey, Hawaii, and Rhode Island, have long-standing mandatory short-term disability insurance programs. The list of states with mandatory paid family and medical leave is expanding. If your state has any of these programs, you’ll register separately, make regular contributions, and show the deductions on employee pay stubs.
Recordkeeping
The IRS requires you to keep employment tax records for at least four years after the tax becomes due or is paid, whichever is later.22Internal Revenue Service. Topic No. 305, Recordkeeping The Department of Labor requires basic payroll records, including each employee’s name, hours worked, wages paid, and deductions, for at least three years, and records used to compute wages (timecards, work schedules) for at least two years.23U.S. Department of Labor. Fact Sheet #21: Recordkeeping Requirements Under the Fair Labor Standards Act (FLSA) The safest approach is to hold everything for at least four years.
Why Penalties Hit Harder for a Sole Proprietor
This is where sole proprietorships differ from corporations in a way that matters. When a corporation fails to remit payroll taxes, the IRS pursues the business entity first. When a sole proprietor fails, the IRS comes directly after you, because you and the business are the same legal person. There is no corporate shield.
The money you withhold from an employee’s paycheck for income taxes and the employee’s share of FICA is held in trust for the government. If you use those funds for other business expenses instead of depositing them, the IRS can assess the Trust Fund Recovery Penalty against you personally, equal to 100% of the unpaid trust fund taxes plus interest.24Internal Revenue Service. Trust Fund Recovery Penalty Using withheld taxes to pay rent, suppliers, or other bills counts as a willful act. For a sole proprietor operating on tight margins, this is the single most dangerous compliance failure.
Even if you intend to pay but miss a deposit deadline, the IRS applies a tiered penalty that rises from 2% for one to five days late to 15% for deposits more than ten days after an IRS demand notice.25Internal Revenue Service. Failure to Deposit Penalty
Tax exposure is only part of it. Because a sole proprietorship offers no liability separation, your personal assets are at risk from employee-related lawsuits. If an employee injures a customer on the job, or if a wage-and-hour complaint lands against you, the claim reaches your personal bank accounts, home equity, and other assets. Workers’ compensation covers workplace injuries but does not insulate you from every type of employee-related claim. Many sole proprietors who grow to the point of multiple employees eventually restructure as an LLC or corporation for that liability protection.