To pay employees as a sole proprietor, you register as an employer with the IRS and your state, collect a W-4 and I-9 from each hire, withhold federal income tax and FICA from every paycheck, match the employer’s share of Social Security and Medicare, deposit those taxes on the schedule the IRS assigns you, file Form 941 each quarter, pay federal and state unemployment taxes out of your own pocket, carry workers’ compensation insurance, and issue W-2s at year end. You handle your own pay separately, through owner’s draws, because a sole proprietor cannot be an employee of their own business.
You Are Not on Your Own Payroll
The IRS does not allow a sole proprietor to be an employee of the business. You cannot put yourself on payroll, withhold taxes from your own check, or issue yourself a W-2.1Internal Revenue Service. Paying Yourself You take money out through an owner’s draw, a plain transfer from the business account to your personal account, with nothing withheld at the time.
Because nothing is withheld, you owe self-employment tax on your net business earnings and generally need to make quarterly estimated tax payments if you’ll owe $1,000 or more when you file.2Internal Revenue Service. Estimated Taxes That is your personal tax picture. Everything else in this article is about paying other people.
Confirm the Worker Is an Employee, Not a Contractor
Before running payroll for anyone, decide whether the person is an employee or an independent contractor. The IRS looks at three categories of evidence: behavioral control (whether you dictate how the work is done), financial control (who supplies tools, who can profit or lose money on the job), and the type of relationship (written contracts, benefits, permanency).3Internal Revenue Service. Employee (Common-Law Employee)
If the person is a true independent contractor, you skip withholding entirely and issue a Form 1099-NEC at year end. If the person is an employee, everything below applies. Misclassifying an employee as a contractor makes you liable for all the employment taxes you should have been paying.4Internal Revenue Service. Worker Classification 101: Employee or Independent Contractor
Register as an Employer
Once you know you’re hiring an employee, get a federal Employer Identification Number. An EIN is a nine-digit number the IRS uses to track your employment tax accounts. A sole proprietor who previously filed only under a Social Security number must apply for one before issuing any paychecks. You can apply online for immediate assignment or submit Form SS-4 by fax or mail.5Internal Revenue Service. Employer Identification Number
Register with your state’s labor or revenue department to set up a state employer tax account. This account handles State Unemployment Tax Act obligations and, depending on the state, state income tax withholding. Registration generates a state employer ID number you’ll use for quarterly wage reporting. SUTA rates vary by industry and claims history, and the taxable wage base differs from state to state.
Federal law also requires you to report every new hire to your state’s new-hire directory within 20 days of the start date, though some states set shorter deadlines. You submit the employee’s name, address, Social Security number, and date of hire, along with your business name, address, and EIN. State agencies feed this data to the National Directory of New Hires, used by child support enforcement agencies to locate parents who owe support.6Administration for Children & Families. New Hire Reporting
Onboarding Forms for Each New Employee
Every new hire completes two forms before starting work. Form W-4 tells you how much federal income tax to withhold. It captures filing status, dependent information, and any extra withholding the employee wants. Make it effective with the first wage payment and keep it on file.7Internal Revenue Service. Hiring Employees
Form I-9 verifies identity and legal work authorization. The employee completes Section 1 no later than their first day of work. You then examine original documents from the approved lists within three business days. A U.S. passport alone satisfies both identity and work authorization, or the employee can present a combination such as a driver’s license plus a Social Security card. You sign to confirm the documents reasonably appear genuine and relate to the person presenting them. Keep every completed I-9 for three years after the hire date or one year after employment ends, whichever is later.8U.S. Citizenship and Immigration Services (USCIS). I-9, Employment Eligibility Verification
Some states require employers to use the federal E-Verify system on top of the I-9. Check your state’s rules when you register your employer account.9E-Verify. Federal Contractors
What You Withhold and Match Each Payday
Federal income tax withholding is driven by each employee’s W-4. Calculate the amount using the tables and procedures in IRS Publication 15, updated annually. The withholding belongs to the employee; you’re collecting it on the government’s behalf.10Office of the Law Revision Counsel. 26 USC 3402 – Income Tax Collected at Source
On top of income tax, you withhold FICA. The employee’s share is 6.2% for Social Security and 1.45% for Medicare, and you match both dollar for dollar. The combined employer-plus-employee rate is 15.3% of each paycheck’s gross wages.11Internal Revenue Service. Topic No. 751, Social Security and Medicare Withholding Rates Social Security tax applies only to wages up to $184,500 in 2026; once an employee’s year-to-date earnings pass that threshold, you stop withholding the 6.2% on both sides.12Social Security Administration. What Is the Current Maximum Amount of Taxable Earnings for Social Security Medicare has no wage cap.
When an employee’s wages exceed $200,000 in a calendar year, you also begin withholding an Additional Medicare Tax of 0.9% from every paycheck for the rest of that year. There is no employer match on this one; the employee pays it entirely.13Internal Revenue Service. Publication 926, Household Employer’s Tax Guide
Depositing the Taxes You Withhold
The income tax and FICA you withhold are trust fund taxes. The money belongs to the government from the moment you deduct it from a paycheck. Your deposit schedule depends on the size of your payroll tax liability during a lookback period. New employers, and those who reported $50,000 or less in total tax liability during the lookback period, deposit monthly by the 15th of the following month. Employers who reported more deposit on a semiweekly schedule tied to their paydays. If you accumulate $100,000 or more in tax liability on any single day, you must deposit by the next business day regardless of your normal schedule.14Internal Revenue Service. Notice 931, Deposit Requirements for Employment Taxes
Late deposits trigger escalating penalties: 2% if you’re 1–5 days late, 5% at 6–15 days, 10% beyond 15 days, and 15% if the tax remains unpaid after the IRS sends a demand notice.15Internal Revenue Service. Failure to Deposit Penalty These percentages replace each other rather than stack, so a deposit that’s 20 days late incurs a 10% penalty, not 17%.
The worst case is the Trust Fund Recovery Penalty. If the IRS determines you willfully failed to collect or pay over withheld taxes, you become personally liable for a penalty equal to 100% of the unpaid trust fund taxes.16Office of the Law Revision Counsel. 26 U.S. Code 6672 – Failure to Collect and Pay Over Tax As a sole proprietor you already have unlimited personal liability, so there is no corporate shield here. This is where most small employers get into irreversible trouble with the IRS.
Filing Form 941 Each Quarter
Each quarter you file Form 941, reporting total wages paid, federal income tax withheld, and both shares of Social Security and Medicare taxes. The form is due by the last day of the month following each quarter’s end: April 30, July 31, October 31, and January 31.17Internal Revenue Service. Instructions for Form 941 (03/2026) Once you file your first 941, you must keep filing every quarter even if you paid no wages that period, unless you notify the IRS that your business has closed or you’re a seasonal employer.
Federal and State Unemployment Taxes
The Federal Unemployment Tax Act imposes a 6.0% tax on the first $7,000 of wages you pay each employee per year. Most employers pay far less, because timely state unemployment tax payments earn a credit of up to 5.4%, dropping the effective FUTA rate to 0.6%, or a maximum of $42 per employee per year.18Internal Revenue Service. Publication 15 (2026), (Circular E), Employer’s Tax Guide FUTA comes entirely out of your pocket; nothing is deducted from employee wages.
State unemployment taxes run parallel to FUTA with wider variation. Taxable wage bases range from $7,000 to over $78,000, and rates depend on your industry and your history of former employees filing unemployment claims. New employers typically receive a standard starter rate that adjusts over time. You report and pay SUTA quarterly to your state labor or revenue agency through the state employer account you set up when registering.
Workers’ Compensation Insurance
Nearly every state requires employers to carry workers’ compensation insurance, which covers medical costs and a portion of lost wages when an employee is injured on the job. The threshold for mandatory coverage varies. Many states require it from the first employee; others exempt businesses with fewer than three to five workers. Some states carve out exceptions for domestic workers, agricultural laborers, or casual employees. Check your state’s labor department for the specific trigger.
Premiums are based on the type of work your employees perform and your total payroll. A desk job costs far less to insure than construction work. Most states allow you to buy coverage from private carriers, though a handful operate state-run funds that serve as the sole or default provider. Failing to carry required coverage can result in fines, stop-work orders, and personal liability for any workplace injury costs.
Minimum Wage and Overtime
The Fair Labor Standards Act sets the pay floor. The federal minimum wage is $7.25 per hour and has not changed since 2009.19U.S. Department of Labor. Wages and the Fair Labor Standards Act Most states set their own minimums above the federal rate, and where a state minimum is higher, you pay the higher amount. Rates change frequently at the state level, so verify yours at the start of each year.
Overtime applies to non-exempt employees who work more than 40 hours in a workweek. You must pay at least one and a half times the regular rate for every hour beyond 40. This requirement cannot be waived by agreement, and it is calculated on a workweek basis, not averaged over a pay period.20U.S. Department of Labor. Fact Sheet #23: Overtime Pay Requirements of the FLSA If you pay biweekly and an employee works 50 hours in week one and 30 in week two, you still owe 10 hours of overtime for that first week.
Running Payroll and Closing the Year
Pick a consistent pay schedule and stick to it. Many states mandate minimum pay frequencies, so biweekly or semimonthly works in most places. You can issue physical checks or set up direct deposit through your bank. Payroll software handles the withholding math, generates pay stubs, and tracks cumulative year-to-date figures automatically. For a business with one or two employees, the cost is modest and the time savings are real.
Each paycheck should come with a pay stub showing gross wages, each tax deduction, any other authorized deductions, and the net amount. Most states require this by law, and even where it is not technically required, detailed stubs prevent disputes and simplify your records at tax time. Keep copies of every stub, digital or paper.
At year end, issue a Form W-2 to each employee and file copies with the Social Security Administration. The deadline for both is January 31 following the tax year.21Social Security Administration. Deadline Dates to File W-2s The W-2 reports total wages, federal and state taxes withheld, Social Security and Medicare wages, and other compensation details. Errors affect employees’ future Social Security benefits, so reconcile the numbers against your quarterly 941 filings before you submit.22Internal Revenue Service. Topic No. 752, Filing Forms W-2 and W-3 Keep copies of all W-2s and the transmittal Form W-3 for at least four years.