Yes, a sole proprietor can have W-2 employees. Nothing about the sole proprietorship structure prevents you from hiring, running payroll, and treating workers as regular employees rather than contractors. What changes the moment you hire is the compliance load: you take on federal and state obligations for tax withholding, employment verification, insurance, and reporting, and because there’s no legal separation between you and the business, any mistake reaches your personal assets directly.
Here’s what hiring actually requires.
Classify the Worker Correctly Before Anything Else
Deciding between W-2 employee and 1099 contractor is the first real decision, and getting it wrong is expensive. The IRS looks at behavioral control (do you direct what the worker does and how), financial control (who provides tools, how the worker is paid, whether expenses are reimbursed), and the nature of the relationship (written contract, benefits, ongoing work that’s core to your business). No single factor decides it; the IRS weighs them together.1Internal Revenue Service. Independent Contractor (Self-Employed) or Employee?
If you call someone a contractor when they should be an employee, you can be held liable for all the employment taxes you should have withheld and paid, including the employee’s share of Social Security and Medicare. That bill comes with penalties and interest. Sole proprietors most often trip on this when hiring part-time help and assuming a 1099 is simpler paperwork. It is simpler, but only if the working relationship genuinely fits.
Get an EIN and Register With Your State
You can’t run payroll without a federal Employer Identification Number. File Form SS-4 with the IRS, which asks why you’re applying, what type of entity you operate, and how many employees you expect to hire in the next 12 months.2Internal Revenue Service. Form SS-4, Application for Employer Identification Number The online application returns your nine-digit EIN immediately.3Internal Revenue Service. About Form SS-4, Application for Employer Identification Number (EIN) The EIN replaces your Social Security number on employment tax filings, which cuts down how often your SSN appears on business documents.
Most states also require a separate state employer ID for state income tax withholding and unemployment insurance, typically issued through your state’s department of revenue and labor agency. Complete both registrations before your new hire’s first day.
Day-One Paperwork: W-4 and I-9
On or before the first day of work, your employee completes Form W-4. This tells you their filing status and any adjustments so you can withhold the right amount of federal income tax.4Internal Revenue Service. Form W-4 (2026) Employee’s Withholding Certificate If they don’t turn one in, you must withhold as if they’re single with no adjustments, which usually means more tax comes out than necessary.
Form I-9 verifies the employee is authorized to work in the United States. Every employer must complete this for every employee, no exceptions.5U.S. Citizenship and Immigration Services. I-9, Employment Eligibility Verification The employee fills out Section 1 on or before their start date. You complete Section 2 within three business days of that start date, and doing so requires physically examining original identity and work-authorization documents such as a U.S. passport or a driver’s license paired with a Social Security card.
Retain each completed I-9 for three years after the date of hire or one year after employment ends, whichever is later. Penalties for I-9 violations are adjusted annually for inflation and can be substantial even for paperwork errors that have nothing to do with knowingly hiring unauthorized workers.
Payroll Taxes: What You Withhold, What You Match
Payroll is where hiring gets expensive, because you don’t just withhold the employee’s share. You pay a matching amount out of your own funds.
Social Security and Medicare
Withhold 6.2 percent of gross wages for Social Security and 1.45 percent for Medicare, then match both amounts yourself. Combined, that’s 15.3 percent of wages split evenly between employer and employee.6Internal Revenue Service. Topic No. 751, Social Security and Medicare Withholding Rates The Social Security portion applies only up to the wage base, which is $184,500 in 2026; earnings above that aren’t subject to the 6.2 percent.7Social Security Administration. Contribution and Benefit Base There is no cap on Medicare tax.
Once an employee’s wages exceed $200,000 in a calendar year, you must also withhold an Additional Medicare Tax of 0.9 percent on the excess. This one is employee-only, so you don’t match it, but you are responsible for withholding it.8Internal Revenue Service. Questions and Answers for the Additional Medicare Tax
Federal and State Unemployment
The federal unemployment tax rate is 6.0 percent on the first $7,000 of each employee’s annual wages. Most employers receive a credit of up to 5.4 percent for state unemployment taxes paid, dropping the effective FUTA rate to 0.6 percent, or a maximum of $42 per employee per year.9Internal Revenue Service. Topic No. 759, Form 940 – Employers Annual Federal Unemployment (FUTA) Tax Return Every state charges its own unemployment insurance tax as well, with new-employer rates that vary widely and adjust over time based on your claims history.
Deposits and Quarterly Filing
New employers with no filing history generally start as monthly depositors. If your total employment tax liability during the lookback period is $50,000 or less, you stay monthly.10Internal Revenue Service. Publication 15 (2026), (Circular E), Employer’s Tax Guide
Every quarter, file Form 941 to report wages paid, federal income tax withheld, and both shares of Social Security and Medicare taxes. The return is due by the last day of the month following the quarter’s end: April 30, July 31, October 31, and January 31.11Internal Revenue Service. Instructions for Form 941 Once you file your first 941, you keep filing every quarter even when you have no taxes to report, unless you notify the IRS that your business has closed or you qualify as a seasonal employer.
Keep all employment tax records for at least four years after the tax is due or paid, whichever is later.12Internal Revenue Service. Employment Tax Recordkeeping That covers pay stubs, withholding records, deposit receipts, and copies of every form you file.
Minimum Wage and Overtime
Hiring an employee brings the Fair Labor Standards Act into play. The federal minimum wage is $7.25 per hour, and you must pay whichever rate is higher between federal, state, and local.13U.S. Department of Labor. Consolidated Minimum Wage Table
Any non-exempt employee who works more than 40 hours in a workweek must receive overtime at one and a half times their regular rate.14eCFR. Part 778 Overtime Compensation Whether an employee qualifies as exempt depends on both duties and salary. Following a court ruling that blocked the Department of Labor’s 2024 update, the salary threshold for the white-collar exemptions currently sits at $684 per week, or $35,568 per year.15U.S. Department of Labor. Earnings Thresholds for the Executive, Administrative, and Professional Exemption Employees earning below that threshold are almost certainly non-exempt regardless of title or duties. Most first hires at a sole proprietorship will be non-exempt, so build overtime tracking into your payroll from day one.
Workers’ Compensation and Other Insurance
Nearly every state requires employers to carry workers’ compensation insurance, which covers medical costs and lost wages for on-the-job injuries. Texas is the notable exception, where coverage is optional; opting out leaves you exposed to employee lawsuits with fewer legal defenses. Premiums depend on your industry, job classifications, and claims history. Office work costs far less to insure than physical labor.
Beyond workers’ comp, consider employment practices liability insurance. Because there’s no legal barrier between you and the business, an employee’s claim for wrongful termination, harassment, or discrimination can reach your personal bank accounts, home, and other assets. A corporation or LLC would shield personal assets from most business liabilities. A sole proprietorship does not.
Postings, New Hire Reporting, and Year-End W-2
Federal law requires you to display labor law posters where employees can see them, covering minimum wage, workplace safety, and equal employment opportunity at a minimum. The Department of Labor’s online Poster Advisor identifies exactly which posters your business needs, and the posters themselves are free from the enforcing agencies.16U.S. Department of Labor. Workplace Posters
Within 20 days of a new employee’s start date, report the hire to your state’s Directory of New Hires. Some states set tighter deadlines.17Office of the Law Revision Counsel. 42 USC 653a – State Directory of New Hires The data feeds child support enforcement, and most states offer an online portal where you enter the employee’s name, address, and Social Security number.18Administration for Children and Families. New Hire Reporting for Employers
At year’s end, furnish each employee a Form W-2 showing total wages and taxes withheld. The deadline for both employee copies and the Social Security Administration submission is January 31 of the following year.19Social Security Administration. Employer W-2 Filing Instructions and Information – First Time Filers Miss it and late-filing penalties climb the longer you wait.
Personal Liability Is the Real Difference
This is what catches people off guard. When you hire as a sole proprietor, every employment obligation sits on you personally. Unpaid wages, tax shortfalls, discrimination claims, workplace injuries without proper insurance: all of it can be collected from your personal assets. There is no corporate veil to pierce because there is no corporate veil at all.
That doesn’t mean you shouldn’t hire. Plenty of sole proprietors run successful businesses with employees. It does mean compliance has to be tight from the start. Set up proper payroll (most sole proprietors use payroll software or a service to handle withholding and tax deposits), put insurance in place before anyone starts work, and keep records organized. The cost of doing it right is always less than the cost of an audit or a lawsuit.