The day you put someone on payroll you stop being solo labor and become an employer, and that changes your business in four concrete ways: you now run payroll and carry a fixed labor cost every week, that cost is far more than the wage, your cash flow and bookkeeping have to absorb it, and a specific legal checklist switches on that you have to complete before day one. None of it is hard once you know the shape of it, but a lot of contractors hire on instinct and get blindsided by the cost and the admin. This guide is the business-owner's map of what changes and where each piece is handled. The step-by-step legal compliance, the payroll-tax math, and the exact per-hour cost each have their own guides, linked where they land.
From writing a check to running a business with staff
Paying a subcontractor was simple: agree a price, write a check, file a 1099 at year-end. An employee is a standing commitment. Now there is a paycheck due every pay period whether or not a customer paid you, tax to withhold and deposit on a schedule, insurance to carry, and a person whose work and safety are your responsibility. You have gone from selling your own hours to running an operation that includes someone else's. That is a real change in what your business is, not just one more errand, so it pays to set it up deliberately.
Decision one: how you will run payroll
Before anything else, decide how payroll actually gets done, because everything else hangs off it:
- A payroll service or software (the route almost everyone takes) calculates the withholding, makes the tax deposits on time, files the quarterly and annual forms, and produces the pay stubs and W-2s. It costs a modest monthly fee and it removes the part of payroll that carries real penalties if you get it wrong.
- A bookkeeper who runs payroll as part of keeping your books, which folds it into work you may already be handing off (see When to hire a bookkeeper or CPA).
- By hand, which is legal but a false economy given how cheap payroll software is and how expensive a missed deposit can be.
The reason to use a service is not laziness. The taxes you withhold from a paycheck are not your money, and the IRS pursues unpaid payroll taxes harder than almost anything, including going after you personally. Let software own the deadlines. Setting this up is covered on the tools side in Accounting software for contractors.
What an employee actually costs you
The wage on the offer is the smallest part of the cost. On top of it you carry your share of Social Security and Medicare, unemployment tax, workers' comp, and any benefits, which together typically add 25 to 40 percent over the base wage. That loaded figure, the payroll burden, is the number you must build into your pricing and your job costing, because an hour billed at bare-wage cost quietly loses money. Price for the burden, not the wage. The exact per-hour math is worked in What does an employee actually cost per hour, and folding it into a bid is in How to price your work.
The legal checklist you must complete (details in its own guide)
Becoming an employer triggers a set of legal must-dos, and every one of them has to be handled before your new hire starts working. In brief:
- Get an EIN if you do not already have one. Free and instant from irs.gov; it is what you file employment taxes under.
- Verify work eligibility on a Form I-9 for the new hire.
- Report the new hire to your state's new-hire directory.
- Put workers' comp in place before they set foot on a site.
- Collect a Form W-4 and put up the required labor-law posters.
The exact timing, forms, and state-by-state pieces of that checklist (the I-9 deadline, new-hire reporting windows, whether E-Verify applies to you, when workers' comp is required and whether it must cover you) are laid out in Hiring your first employee the legal way, and the state specifics route to Working in Your State. Do not treat any of it as optional; the workers' comp piece in particular can end a business if you skip it and someone gets hurt.
The tax side, in one line
Once you run payroll you withhold income tax plus the employee's Social Security and Medicare, match part of it yourself, pay federal unemployment tax, and deposit it all on a set schedule with the right forms. That is a whole topic on its own, worked in full in What payroll taxes do I owe when I hire my first employee. Your payroll service handles the mechanics; the guide explains what you are paying and why.
How hiring ripples through the rest of your business
The paperwork is the visible part. The changes that actually catch owners out are the knock-on ones:
- Cash flow gets tighter and less forgiving. Payroll is due on payday no matter what your customers have done. A slow-paying client that used to just delay your own money now means covering someone else's wages out of your buffer. This is exactly why a cash reserve and a line of credit come before your first hire (see Managing cash flow in a feast-or-famine trade).
- Your bookkeeping gains a new dimension. You now track labor by job, at the loaded cost, to keep job costing honest (see Bookkeeping for the trades). Payroll records and W-4s join the file.
- Your insurance picture grows. Workers' comp is new, your general liability may change with employees on site, and if the new hire drives for you, commercial auto comes into play (see What insurance do I need).
- You now manage a person, which is time off the tools and a real part of the job going forward (the strategic side of that is in Growing from solo to a crew).
The one trap to name up front
The most expensive first-employer mistake is labeling someone a "1099 subcontractor" to avoid all of the above. The government decides who is genuinely an employee based on the facts, not the label, and the back taxes, penalties, and comp exposure for getting it wrong all land on you. If the work needs an employee, hire one properly. Whether a given worker should be W-2 or 1099 is worked through in Employees vs subcontractors for your business and 1099 vs W-2.
Common questions
Should I use a payroll service or run payroll myself?
For almost every small contractor, use a payroll service or software, because the cost is modest and the penalties for doing it wrong are not. A service calculates withholding, makes the tax deposits on time, and files the forms, which matters because the taxes you withhold are not your money and the IRS pursues unpaid payroll taxes aggressively, including personally. Running payroll by hand is legal but rarely worth the risk of a missed deposit. If you are already handing your books to a bookkeeper, they can often run payroll too. Reserve DIY payroll for when you genuinely understand the deposit schedule and forms.
What is the first thing I need to set up before my first employee starts?
Have your EIN, workers' comp, and a payroll system in place before their first day, and complete the legal onboarding steps on day one. The EIN (free from irs.gov) is what you file employment taxes under, workers' comp protects you from a catastrophic injury bill, and a payroll system handles the withholding and deposits you are now responsible for. The legal must-dos, verifying eligibility on a Form I-9, reporting the hire to your state, and the posters, are laid out in Hiring your first employee the legal way. Do not let anyone start working before comp is in force.
How much does an employee really cost above their hourly wage?
Budget roughly 25 to 40 percent on top of the base wage once you add your share of payroll taxes, unemployment tax, workers' comp, and any benefits. That loaded figure is the payroll burden, and it is the cost you must build into your pricing and job costing, not the bare wage. Price a job on wages alone and it will look profitable while actually losing money on labor. The exact per-hour calculation is worked in What does an employee actually cost per hour, and building it into a bid is covered in How to price your work.
How does hiring change my cash flow?
It makes it tighter and far less forgiving, because payroll is due on payday whether or not your customers have paid you. Solo, a slow-paying client just delayed your own money; with an employee it means covering someone else's wages out of your reserve while you wait. That is why a cash buffer and, ideally, a line of credit should be in place before you hire, not after. More people on the payroll multiplies this timing risk, so tighten your invoicing and deposits first. The full picture is in Managing cash flow in a feast-or-famine trade.
Can I just pay my first worker as a 1099 to avoid becoming an employer?
No, not if the facts make them an employee, and you do not get to choose based on what is easier for you. If you control how, when, and where they work, provide the tools, and they work mainly for you, they are an employee regardless of the form you file, and misclassifying them to dodge payroll taxes and workers' comp exposes you to back taxes, penalties, and interest, all landing on you. If the work genuinely suits an independent sub, that is a legitimate option weighed in Employees vs subcontractors for your business. The deciding test is in 1099 vs W-2.
The honest bit
- The state-varying pieces of hiring (when workers' comp is required and whether it covers you, your state's new-hire reporting deadline, SUTA registration, any E-Verify mandate, minimum wage, and state posters) route to Hiring your first employee the legal way and Working in Your State. Do not assume another state's rule is yours.
- Payroll burden of 25 to 40 percent is a national planning range, not a fixed number; your actual burden depends on your comp class and benefits.
- The federal onboarding and payroll mechanics are current for 2026; confirm at irs.gov, uscis.gov, and dol.gov before relying on a deadline.
- This is general guidance, not legal or tax advice. A payroll service or CPA setting it up correctly the first time is money well spent.
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Templates you might need
Sources
- IRS - Hiring employees · The EIN, the Form W-4 and the Form I-9 verification duty that all start on the first hire
- IRS - Employment taxes · What an employer withholds and what it pays on top: income tax withholding, the employer's share of Social Security and Medicare, and federal unemployment tax
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