Can a Sole Proprietor Have Employees?

When you started your business, you may have decided that the sole proprietorship business structure was best due to its simplicity and flexibility. Sole proprietorships are business entities that are not registered at the state level and have one owner who is considered self-employed, meaning that paperwork and taxes are fairly straightforward. 

But what happens as your company grows? Can sole proprietors have employees, and if so, how many? 

Sole proprietors can hire any number of employees, but before doing so, make sure that you are aware of the legal and administrative responsibilities involved.

Operating a sole proprietorship

A sole proprietorship is a business owned and managed by one person, also known as the owner. The main difference between this business type and other types is that a sole proprietorship isn’t a registered entity (whereas entities like a limited liability company and a corporation must be registered with their state).

Because states do not consider sole proprietorships and their owners as separate entities, the owner reports all income and losses to the business on their personal income taxes. This means that any liabilities incurred by the business are also the liabilities of the owner. Sole proprietorships typically submit quarterly estimated tax payments, then file their income tax return annually.

Commonly, owners operate their sole proprietorships under their personal name. However, they may use an assumed or fictitious name, also called a doing business as (DBA) name, by filing paperwork with the appropriate jurisdiction.

Can sole proprietors have employees?

A sole proprietor can hire an unlimited number of employees, but just like any other company, must follow all laws—local, state, and federal—regarding those hires. Sole proprietorships follow many of the same rules as any other business, even though they only have one person as the owner and manager and despite not having to register as a business entity in their state.

It’s important to note that hiring employees—no matter your business type—introduces additional responsibilities and legal obligations. Because sole proprietorships have no legal separation between themselves and their business, any financial or legal issues with having employees may put their personal assets at risk. For some owners, it may be best to restructure the business as an LLC for liability protection. 

Maybe you’re also wondering, “Can a sole proprietor have employees who are family members?” The answer is yes, a sole proprietor may hire a spouse or child. Oftentimes, sole proprietorships start out as a solo venture, but a growing business may demand extra sets of hands. To get the help they need, sole proprietors may first turn to family members.

Hiring a spouse

As long as your spouse is under the control of the business owner (you), they are considered an employee. Different legal and tax requirements apply if your spouse is brought on to share in the control and management of the business; in this case, your business would be considered a partnership or a qualified joint venture.

When hiring a spouse, sole proprietors must follow certain guidelines, including paying the spouse either real wages or tax-free fringe benefits (like a health reimbursement account or life insurance), ensuring that the spouse is performing real business duties, and compensating them reasonably compared to other employees or industry standards.

With sole proprietorships, there are several advantages of hiring a spouse vs. hiring an employee outside the family: 

• Federal and state minimum wage requirements typically aren’t enforced.
• Payment doesn’t have to be in the form of cash wages; instead, it can be in other benefits, which help save on taxes.

If you do decide to pay your spouse a real wage, you’ll need to have them fill out a W-4 form, withhold Federal Insurance Contribution Act (FICA) taxes for Medicare and Social Security, potentially withhold income tax, and provide them with an annual W-2. Employed spouses are not subject to the federal unemployment tax.

Hiring children

A sole proprietor can hire their child, but they must follow all federal and state child labor laws. These laws generally set the minimum hiring age at 14, don’t allow children under the age of 18 to perform dangerous tasks or operate certain machinery, regulate the number of hours worked,  and specify work time frames for 14- and 15-year-olds. Some states require that minors have a work permit and that employers have a permit to employ and work.

There may be tax advantages to hiring a child because you can deduct their salary from your business’ income. Additionally, sole proprietors don’t have to withhold FICA taxes from their child’s pay, and child employees typically don’t owe federal income taxes if they’re paid less than the standard deduction.

To avoid any legal issues, remember to pay applicable payroll taxes, have your child fill out a W-4 form, document their hours worked and duties, and provide them with a W-2 at year’s end.

Learn more about paying payroll taxes when hiring family members.

How to hire employees for a sole proprietorship

Hiring employees is an exciting step for many business owners, but make sure that you follow these eight steps to ensure that you’re in compliance with federal and state laws and employer best practices.

1. Obtain an EIN

Every business, including a sole proprietorship, that wishes to hire employees must first obtain an employer identification number (EIN). This involves registering with the Internal Revenue Service as an employer. An EIN acts as a Social Security number for a business and is needed for tax filings and other business purposes, such as opening a business bank account.

You can obtain an EIN by applying online through the IRS website, by fax, or by mail. Or you can use LegalZoom’s EIN service for a seamless application, filing, and verification process.

2. Register for and pay taxes

As mentioned earlier, sole proprietorships do not register as a business entity with the relevant state agency, which is typically the Secretary of State. However, if a sole proprietorship has employees, it’s usually required to register as an employer with its state labor agency. Be sure to check with your state guidelines to ensure that your business is compliant.

Then, after employment has begun, the sole proprietor must withhold all required employment taxes from the worker's wages and contribute appropriate employer taxes. The business must deposit taxes and file payroll reports as required by state and federal law. Sole proprietors must withhold from employee wages (if applicable), FICA taxes, federal and state unemployment taxes (if applicable), and other required payroll taxes. 

3. Obtain workers' compensation insurance

Most states require employers—regardless of their business entity type—to purchase workers’ compensation insurance. Workers’ comp financially covers medical expenses and lost wages if employees are injured on the job.

In tandem with purchasing this insurance, draft a workplace injury report that can be used in the event of a work-related employee injury.

4. Set up payroll systems

Establish a reliable payroll system to manage employee compensation and tax withholdings. Small businesses like sole proprietorships often don’t have employees dedicated to handling payroll, so instead of handling it yourself, seek out a reputable payroll service that can do the work for you. Many platforms handle payroll, benefits, time tracking, and annual tax filings.

5. Gather employee information

Whether you’re hiring your first employee or your fourth, you must have each worker fill out the appropriate employment forms:

• W-4. This form is used to determine the correct amount of income tax to withhold from the employee’s wages. The IRS website provides a downloadable version of the most up-to-date W-4 form.
• I-9. This form, along with submitting proof of identification, is used to certify that the employee is legally authorized to work in the United States. Download the I-9 form from the U.S. Citizenship and Immigration Services website.

6. Create employee policies

When you have a staff, setting and communicating employee policies, expectations, and procedures is key to a positive, consistent workplace environment. An employee handbook sets the tone for what employees can expect while working for your business. It should cover things like employee benefits, time off, and leave; your code of conduct; disciplinary actions; equal opportunity employer statements; and so on. 

To ensure that you cover everything you need to, get attorney support with LegalZoom’s legal services for employee handbook development. We help you create, revise, and customize your handbook according to your business’s needs. 

7. Post required notices

Some federal and state Department of Labor regulations require employers to display labor law posters in a conspicuous location where they can be easily viewed by employees, such as in a physical workplace or on the company intranet. Some state labor law posters may even be emailed to employees.

Use the U.S. Department of Labor FirstStep poster adviser to understand which posters you need to display. Visit your state’s Department of Labor website for state labor law poster requirements. 

8. Maintain compliance with all labor laws

All businesses with employees follow all local, state, and federal laws regarding workers, which cover everything from minimum wage and overtime pay to workplace safety. Because there are many regulations to follow, it’s recommended that sole proprietors consult an employment attorney who can ensure that their business is compliant with the law. 

Pros and cons of hiring employees as a sole proprietor

Before hiring employees, consider the potential advantages and disadvantages of adding more people to your operations.

Pros 

• Increased capacity to serve customers and grow the business.
• Ability to delegate tasks and focus on strategic planning.
• A child employee’s pay is a deductible business expense.
• For spouse hires, minimum wage requirements may not apply and payment can be in the form of tax-free fringe benefits instead of real wages.

Cons

• Additional administrative workload from training, supervising, and managing employees.
• Increased financial responsibilities, including payroll, benefits, and insurance.
• Need for compliance with complex state and federal employment laws.
• Legally and financially liable for employee mistakes or actions.

How to pay employees as a sole proprietor

Follow these simple steps to learn how to pay employees as a sole proprietor:

• Calculate gross pay. Gross pay is the total amount of earned wages before deductions are taken. Sole proprietors pay employees typically via hourly wages or a salary. For hourly workers, calculate gross pay by multiplying their hourly rate by the number of hours worked. For salaried employees, gross pay is calculated by dividing their yearly salary by the number of pay periods in that year.
• Withhold taxes. There are several types of taxes that can be withheld from employees’ wages, including pre-tax (e.g., health insurance premiums), statutory (e.g., federal income tax), and post-tax deductions (e.g., Roth IRA contributions). 
• Pay employees. Employees receive their net pay, or take-home pay, after the appropriate taxes are withheld.

Now that you know the answer to “Can a sole proprietor have employees?” and the ins and outs of hiring new staff, help your business grow with our suite of sole proprietorship services, such as registering a DBA, obtaining the proper licenses, and more.

FAQs

How does hiring employees impact a sole proprietor’s taxes?

A sole proprietor pays state and federal income tax as an individual, not a business, and can take certain deductions. Hiring employees might mean that a sole proprietor can deduct wages (if applicable) and certain benefit programs on their tax return.

What are the alternatives to hiring employees as a sole proprietor?

If a sole proprietor doesn’t want to take on the legal and financial responsibilities of hiring employees, an alternative is to hire an independent contractor. Sole proprietors only pay the contractor’s wage outlined in the independent contractor agreement; the contractor is responsible for their own income tax and benefits. 

How can a sole proprietor manage the added responsibilities of having employees?

Managing the added responsibilities of having employees can be overwhelming for sole proprietors. To ensure that the business runs smoothly—operationally, legally, and financially—it’s important to get help where you need it. For example, you could consult an employment attorney when drafting an employment handbook, and you can utilize payroll services to manage employee pay and benefits.

Is there a difference between sole proprietor vs. individual taxes?

No, there is no difference between sole proprietor vs. individual taxes. That’s because a sole proprietorship is taxed at the individual level, not as a business; it is considered a pass-through tax entity. The owner of the sole proprietorship will pay income tax on their personal tax return, just like any individual does.

How many employees can a sole proprietor have?

A sole proprietor can have an unlimited number of employees. It’s important to keep in mind that the level of liability risk, financial responsibility, and legal compliance increases when hiring employees as a sole proprietor.