Why This Is a Bigger Deal Than You Think
Hiring your first employee is the single biggest legal and financial shift your business will go through after formation. You go from being a solo operator to being an employer, and with that comes a stack of federal, state, and local obligations that don't care whether you knew about them or not.
This guide walks you through every step so you don't get blindsided.
Step 1: Get Your EIN
If you don't already have an Employer Identification Number, you need one before you can hire anyone. You can apply for free at IRS.gov -- it takes about five minutes online and you get the number immediately.
Do not pay a third-party service to get your EIN. It's free directly from the IRS.
Step 2: Register With Your State
Every state has its own requirements for employers. At minimum, you'll need to:
- Register with your state's department of labor
- Set up a state tax withholding account
- Register for unemployment insurance (more on this in our workers' comp guide)
- Check whether your state requires disability insurance or paid family leave
Some states require registration within days of your first hire. Don't wait.
Step 3: Verify Work Eligibility
Federal law requires you to verify every employee's identity and work authorization using Form I-9. This must be completed within three business days of the employee's start date.
You'll also want to check whether your state requires E-Verify. Some states mandate it for all employers, others only for government contractors or businesses above a certain size.
Step 4: Set Up Payroll and Tax Withholding
Before your employee's first day, you need:
- Form W-4 from the employee (federal tax withholding elections)
- A payroll system or payroll provider to calculate and remit taxes
- The ability to deposit federal taxes (EFTPS enrollment)
- State withholding forms if your state requires them
You are responsible for withholding federal income tax, Social Security tax (6.2%), and Medicare tax (1.45%) from every paycheck. You also pay the employer portion of Social Security and Medicare -- another 7.65%.
Step 5: Report the New Hire
Federal law requires you to report every new hire to your state's new hire reporting agency within 20 days (some states require it sooner). This is how the government tracks child support obligations and prevents fraud.
Step 6: Get Workers' Compensation Insurance
Nearly every state requires workers' comp coverage as soon as you have one employee. A few states (like Texas) make it optional, but carrying it is almost always the smart move. We cover this in detail in our workers' comp guide.
Step 7: Display Required Posters
The Department of Labor requires you to display certain workplace posters where employees can see them. These cover minimum wage, OSHA rights, FMLA (if applicable), and anti-discrimination laws. You can download them free from DOL.gov.
If you have a remote employee, check DOL guidance on electronic posting.
Step 8: Classify Correctly
This is where many small business owners get into trouble. There is a massive legal difference between an employee and an independent contractor. The IRS, DOL, and your state all have tests for this, and they don't always agree.
The general rule: if you control how the work gets done (not just what gets done), that person is probably an employee. Misclassification can result in back taxes, penalties, and lawsuits.
Step 9: Understand Your Obligations
Once you have an employee, you're subject to:
- FLSA: Minimum wage and overtime rules
- OSHA: Workplace safety requirements
- Anti-discrimination laws: Title VII applies at 15+ employees, but many state laws kick in at 1 employee
- ACA: If you grow to 50+ full-time equivalent employees, you'll have health insurance obligations
What Most Owners Get Wrong
The biggest mistake is treating this like a paperwork exercise. Hiring your first employee changes your risk profile, your tax obligations, and your legal exposure. Get a payroll provider set up before day one. Talk to an employment attorney if you have any doubt about classification. And keep records -- the IRS and DOL both love documentation.
Your First-Hire Checklist
- Obtain EIN from IRS
- Register with state labor and tax agencies
- Set up payroll and tax withholding
- Have employee complete W-4 and I-9
- Report new hire to state agency
- Obtain workers' compensation insurance
- Post required workplace notices
- Verify correct worker classification
- Establish a personnel file system
The True Cost of Your First Employee: A Complete Breakdown
Beyond the salary number, here is what your first employee actually costs:
| Cost Component | Calculation | Example at $50,000 Salary |
|---|---|---|
| Base salary/wages | Agreed amount | $50,000 |
| Employer FICA (Social Security + Medicare) | 7.65% of wages | $3,825 |
| Federal unemployment (FUTA) | 0.6% of first $7,000 | $42 |
| State unemployment (SUTA) | 2.7% average for new employers on $7,000-$50,000+ | $189-1,350 |
| Workers' compensation insurance | $1-15 per $100 of payroll (varies by industry) | $500-7,500 |
| Payroll processing | $40-100/month | $480-1,200 |
| Health insurance contribution (optional) | $300-700/month employer share | $3,600-8,400 |
| Paid time off (10 days) | Salary cost for days not worked | $1,923 |
| Equipment and workspace | Computer, desk, tools, etc. | $1,000-5,000 |
| Training time | Weeks of reduced productivity | $2,000-5,000 |
| Total first-year cost | $63,559-83,240 | |
| Overhead multiplier | 1.27x-1.66x salary |
The general rule: budget 1.25-1.4 times the base salary for total employer cost, or 1.5-1.7 times if you include health insurance. At a $50,000 salary, your true cost is $62,500-85,000.
Employee vs. Independent Contractor: The Decision That Matters Most
This is where most first-time employers get into trouble. The consequences of misclassification are severe -- back taxes, penalties, and potential lawsuits.
Quick classification test -- if you answer "yes" to 3 or more of these, the worker is likely an employee:
- You control WHEN they work (set hours or schedule)
- You control WHERE they work (your location required)
- You control HOW they do the work (your methods and processes)
- You provide the tools and equipment
- They work exclusively or primarily for you
- The relationship is ongoing with no defined end date
- They are performing work that is your core business activity
- You provide training on how to do the work
If the worker is an employee, you MUST withhold taxes, provide workers' comp, and comply with wage and hour laws. Calling them a "1099 contractor" when they function as an employee does not change the legal reality.
When to Hire: The Financial Decision Framework
Hire your first employee when the financial math works:
The 2x rule: The revenue the employee generates (or enables you to generate) should be at least 2 times their fully loaded cost. If the employee costs you $65,000 per year (salary plus overhead), they should generate or free up at least $130,000 in revenue.
The time-value calculation: If you are spending 20 hours per week on tasks a $20/hour employee could handle, that is 1,000 hours per year of your time. If your time generates $100/hour in billable work, those 1,000 hours represent $100,000 in potential revenue versus the $35,000 cost of the employee (including overhead). The decision is clear.
Warning signs you are hiring too early:
- You do not have enough consistent work to keep the employee busy 40 hours per week
- Your revenue has not been stable for at least 6 months
- You do not have 3 months of the employee's salary in cash reserves
- You are hiring because you are busy this month, not because demand is consistent
State-by-State New Employer Requirements
Requirements vary significantly by state. Here are common items that differ:
| Requirement | Common Variations |
|---|---|
| State tax withholding | Most states require it; AK, FL, NV, NH, SD, TN, TX, WA, WY have no state income tax |
| New hire reporting deadline | Federal: 20 days. Many states require faster reporting (some within 10 days) |
| Workers' comp trigger | Most states: 1 employee. AL: 5 employees. TX: optional |
| Disability insurance | Required in CA, HI, NJ, NY, RI, PR |
| Paid family leave | Required in CA, CO, CT, DC, DE, MA, MD, MN, NJ, NY, OR, RI, WA |
| Paid sick leave | Required in 15+ states and many cities |
| E-Verify | Required in some states for all employers; others only for government contractors |
| Minimum wage | Federal: $7.25/hr. 30+ states have higher minimums (up to $16.28+ in WA) |
Check your state's specific requirements before your first hire. Your state's department of labor website is the authoritative source.
Setting Up Payroll: Your Options
You have three main options for payroll processing:
| Option | Monthly Cost | Best For | Pros | Cons |
|---|---|---|---|---|
| DIY (manual calculation) | $0 | Not recommended | Free | Error-prone, time-consuming, risky |
| Payroll software (Gusto, ADP Run, QuickBooks Payroll) | $40-100 base + $6-12/employee | 1-25 employees | Automated tax filing, direct deposit, compliance support | Monthly cost |
| Full-service payroll provider (ADP, Paychex) | $100-300+ base + per-employee fees | 10+ employees or complex needs | Hands-off, dedicated support, HR add-ons | Higher cost |
| Your accountant | $100-300/month | Very small businesses with an existing accountant relationship | Personalized service | Dependent on one person |
For your first employee, a payroll software platform like Gusto ($40 base + $6 per employee per month) handles tax withholding calculations, direct deposit, tax filings (federal, state, and local), W-2 generation, and new hire reporting. The $46 per month is some of the best money you will spend as a new employer.
4Sources
- 01
- 02Employer ID Numbers (EINs) — IRS.gov
- 03
- 04Employment Eligibility Verification (I-9) — USCIS.gov
Frequently Asked Questions
When should a small business hire its first employee?
Hire when you are consistently turning away work or when a specific task consumes more than 20 hours per week of your time. The general rule is to hire when the cost of NOT hiring (lost revenue, burnout, quality decline) exceeds the fully loaded cost of the employee by at least 2x.
How much does it cost to hire your first employee?
Beyond salary, budget for employer payroll taxes (7.65% FICA), workers' compensation insurance ($1-15 per $100 of payroll depending on industry), state unemployment insurance (typically 2.7% for new employers), and setup costs like payroll software ($40-100 per month). Total employer costs are typically 15-25% on top of wages.
What paperwork do I need before hiring my first employee?
You need an EIN from the IRS (free, takes 5 minutes online), state labor and tax agency registration, a payroll system, Form W-4 and I-9 from the employee, new hire state reporting, workers' compensation insurance, and required workplace posters from DOL.gov. Have everything set up before their first day.
Do I need workers' comp for one employee?
In most states, yes -- workers' compensation is required as soon as you have one employee. A few states like Alabama require it at 5+ employees, and Texas makes it optional. Even where optional, carrying it is strongly recommended because without it, you are personally liable for all injury costs and can be sued for damages.
What is the penalty for misclassifying an employee as an independent contractor?
The IRS charges 1.5% of wages for failure to withhold, plus 20% of the employee's FICA share, plus 100% of the employer's share, plus penalties and interest. State penalties add $5,000-25,000 per misclassified worker. You may also owe back wages, overtime, and benefits. Willful misclassification doubles federal penalties.