The paperwork before a first employee starts, in the order it has to happen

The first hire is an administrative event as much as a staffing one. A sole proprietor with one employee has payroll tax obligations, insurance obligations, posting obligations and record-keeping obligations that did not exist the week before.

Most of it is straightforward and most of it has to be in place before the first day. The order below is arranged by dependency: each step needs the one above it.

1. Employer identification number

The federal identifier used for payroll tax filings. A sole proprietor without employees may have operated on a Social Security number; with an employee, an EIN is required.

It is obtained from the IRS at no cost and issues immediately through the online application. Everything downstream needs this number, so it goes first.

2. State registrations

Two separate registrations in most states, and they are handled by two different agencies.

• State income tax withholding. Registers you to withhold and remit state income tax from wages. Not applicable in states without a wage income tax.
• State unemployment insurance. Registers you as an employer for unemployment tax, and issues an account number and an assigned rate. New employers usually receive a standard starting rate that adjusts over time based on claims experience.

Some states add local registrations, and a few municipalities levy their own payroll taxes. Check the city as well as the state.

3. Workers' compensation coverage

Required in nearly every state once you have employees, with the threshold and the details varying. It is not optional insurance and it is not covered by a general liability policy.

Three things to get right:

1. The classification code. Premium is driven by the class of work, and the difference between an office code and a construction code is enormous. Misclassifying to save premium creates a serious problem at audit.
2. The payroll estimate. Policies are estimated at the start and audited at the end. An underestimate produces a bill.
3. The effective date. Coverage must be in force on the first day of employment, not the first payroll.

4. Payroll system

Decide before the first pay period, because the first one is the hardest to correct.

What it has to do: calculate withholding, remit deposits on the correct schedule, file quarterly and annual returns, and produce year-end wage statements. Deposit schedules are set by rules rather than by preference, and late deposits carry penalties that begin small and escalate.

A payroll service or an accountant handling it is the usual answer for a first employee, because the cost is modest against the penalty exposure and the time.

5. The forms the employee completes

These happen at or before the start date.

• Form W-4. Federal withholding. The employee completes it; you keep it and apply it. Many states have their own equivalent.
• Form I-9. Employment eligibility verification. Section 1 is completed by the employee no later than the first day of work, and the employer examines documents and completes Section 2 within three business days of the start. Keep I-9s separately from personnel files, since they may need to be produced on their own.
• State new hire reporting. Employers report each new hire to a state directory within a set number of days. This is a real requirement that first-time employers routinely miss.
• Direct deposit authorization, if used, and any state-required pay notice describing rate and pay day.

6. Classification decisions, made deliberately

Two determinations, and both are made by law rather than by preference.

Employee or independent contractor. Determined by the degree of control over how the work is done, the financial arrangement, and the nature of the relationship. Several states apply stricter tests than the federal one.

Exempt or non-exempt from overtime. Determined by duties and by salary level under federal rules and by state rules where they are stricter. Job title has no bearing on it. The Department of Labor administers the federal wage and hour standards, and the state labor agency administers anything stricter.

Getting either wrong is expensive to fix retroactively, and both are cheap to get right at the start.

7. Posters and notices

Federal and state law require certain notices displayed where employees can see them. The specific set depends on the state, the industry and the size of the business. They are available at no cost from the issuing agencies, and the paid poster services sell convenience rather than anything unavailable.

In a workplace where employees do not report to a common location, the requirement is usually satisfied by electronic distribution, and the rules for that are worth checking.

8. Records, set up before there is anything to file

• Hours worked and wages paid for every non-exempt employee, retained for the period the applicable rules require.
• The personnel file: offer letter, job description, signed policy acknowledgments, performance notes.
• Separate confidential files for medical information and for I-9s.
• Payroll registers and tax filings by quarter.

9. The handbook question

Not required, and useful sooner than most owners expect. Even a short document setting out pay periods, time off, attendance, safety expectations and a complaint procedure resolves arguments that otherwise turn on memory.

Keep it short and keep it accurate. A handbook describing a policy you do not follow is worse than none, because it becomes the standard you are measured against.

The sequence in one pass

1. EIN.
2. State withholding and unemployment registrations.
3. Workers' compensation in force from day one.
4. Payroll system selected and configured.
5. W-4, I-9 and state forms completed on schedule.
6. New hire report filed.
7. Posters up.
8. Record-keeping structure created.

Worked through in order, this is a week of intermittent effort and a modest ongoing cost. Done afterward, under a deadline, with a payroll already run, it becomes the kind of correction that takes an accountant and a quarter to unwind.