Hiring your first employee: the full cost

In short

A friend of mine hired her first employee last spring and found the real bill was far bigger than the paycheck. If you are thinking about doing the same, start by listing every cost, not just the wage. Expect to pay payroll taxes, insurance, and some time spent on paperwork. Get an employer identification number, which is a nine digit tax ID from the IRS, before the first day. Ask your state about workers' compensation and unemployment insurance. Add it all up, then compare it to what you can truly carry for a full year.

The whole of it

What it is

I once watched a baker figure that a $20 an hour helper would cost her $20 an hour. She was kind, and she was wrong. The wage is only the front door of the bill. Behind it sit taxes the employer must pay, insurance the state may require, and the plain cost of your own hours spent on rules and forms.

If you are about to hire, you are probably doing it because the work has outgrown you. That is a good problem to have. It means people want what you make. The full cost of the first hire is simply the wage plus everything the law and good sense add on top of it.

How it works

A friend of mine says the paycheck is the visible part of an iceberg. The rest sits below the water. Let us walk through what sits down there.

First comes the employer share of Social Security and Medicare tax. The employer pays one half and the employee pays the other half. Social Security is the current figure, which the official source publishes each year percent from the employer on wages up to a yearly cap of the current figure, which the official source publishes each year. Medicare is the current figure, which the official source publishes each year percent from the employer, with no cap. The employer must also withhold the employee's half from each paycheck and send both halves to the government.

Next comes federal unemployment tax, often called FUTA. The IRS sets the rate and the wage base each year, and the employer pays it alone. Most states add their own unemployment tax on top. Your state rate depends on your state's rules and on your own history, so a new business often starts with a standard rate. Check your state workforce agency for yours.

Then comes workers' compensation, which pays medical bills and lost wages when an employee is hurt on the job. Most states require it for employers with even one worker, though the rules differ by state and by type of work. The premium is usually a rate per $100 of payroll, and the rate depends on the job's risk. An office clerk costs far less to cover than a roofer.

Some states and cities add more. A few require paid sick leave, disability insurance, or paid family leave contributions. Your state labor department lists what applies where you work.

Health insurance and retirement matches are different. A small employer is generally not forced by federal law to offer them, though the rules shift as a business grows. Many owners offer them to win good people. Treat them as a choice you price in, not a hidden trap.

Last, there is your time. Payroll, new hire forms, and tax deposits take hours. Many owners pay a payroll service so the filings are done right. That fee is a real cost too.

The numbers, and where to find yours

You have probably wondered where to look for the true figures. Good news. The sources are free and official.

The IRS publishes Publication 15, called the Employer's Tax Guide. It lists the current Social Security wage base, the Medicare rate, and the deposit rules. It is the first place to check. The IRS also publishes Publication 15 A for special cases and the Form 941 instructions for the quarterly return.

For FUTA, read the instructions for IRS Form 940. They show the rate and the wage base for the year.

For state unemployment tax, visit your state workforce agency's website. For workers' compensation, visit your state's workers' compensation board or insurance department. Then ask an insurance agent for a quote based on the job duties. The U.S. Department of Labor also has a page that points to state labor offices.

New hires must complete Form W 4 for tax withholding and Form I 9 to prove they may work in the United States. The employer must also report each new hire to the state, and the state's new hire reporting page tells how.

Do not trust any number from memory, including the ones I keep in my head. Rates change. Read the page for the year you are in.

A worked example

I once knew a woodworker named Dana who ran a small shop in Ohio. She hired her first helper, Marcus, at $20 an hour for 30 hours a week. Dana wanted to know the true yearly cost before she said yes.

Start with wages. 30 hours a week times 52 weeks is 1,560 hours. At $20 an hour, 1,560 hours is $31,200 in wages for the year.

Now the employer share of payroll tax. For this example, Dana used 7.65 percent as the combined employer rate for Social Security and Medicare. That figure is the one the IRS lists in Publication 15, so she confirmed it before she counted on it. $31,200 times 0.0765 is $2,386.80, or about $2,387.

Next, unemployment taxes. Dana's state sent her a rate of 2.7 percent on the first $9,000 of pay, and she paid FUTA at a rate of 0.6 percent on that same $9,000. She checked both numbers on the agency pages. State tax is $9,000 times 0.027, which is $243. FUTA is $9,000 times 0.006, which is $54. Together they come to $297.

Then workers' compensation. Her agent quoted $3 per $100 of payroll for shop helpers. $31,200 divided by 100 is $312. And $312 times $3 is $936.

Add a modest payroll service at $40 a month. 12 months times $40 is $480.

Now the total. $31,200 plus $2,387 plus $297 plus $936 plus $480 is $35,300. That is the cost before any health plan or retirement match, and before any state extras.

Dana compared that to the $31,200 wage. The extra was $4,100, which is about 13 percent on top of pay. Her real cost per hour was $35,300 divided by 1,560 hours, or about $22.63 an hour. Marcus earned $20, and Dana's true price was $22.63.

She did not feel tricked. She felt ready. That is the whole point of doing the math first.

Where it goes wrong

A neighbor of mine paid a helper in cash for two years and called him a contractor. Then the state came knocking. It is easy to see why people do it, since the paperwork feels like a burden. But the rules about who counts as an employee depend on how the work is truly done, not on what the owner calls it. The IRS and the Department of Labor both explain the tests on their websites. If the business controls when, where, and how the work is done, the worker is likely an employee. Read those pages before you decide.

Late tax deposits cause trouble too. The employer holds the worker's withheld tax in trust for the government. The employer must deposit it on schedule, and the IRS adds penalties when deposits come late. A payroll service helps here, or a calendar with firm reminders.

Skipping workers' compensation is another sore spot. If a worker is hurt and the employer has no coverage where the state requires it, the employer may face fines and the full medical bill. That risk is far larger than the premium.

Forgetting the overtime rule hurts people as well. Under the Fair Labor Standards Act, many hourly workers must be paid time and a half after 40 hours in a week. Some roles are exempt, but the test is narrow. The Department of Labor's Wage and Hour Division explains it.

Last, many owners forget to budget for slow months. A wage is owed in a slow week just like a busy one. Leave room for that.

Questions to answer before you leave this page

Can your business carry the full cost of one hire, not just the wage, for a whole year, even if sales dip for a few months? Have you got an employer identification number, and have you checked what your state requires for unemployment tax and workers' compensation? Is the person you have in mind truly an employee under the IRS and Department of Labor tests, or could the work be done by an independent contractor? Have you read the current IRS Publication 15 and your state agency pages so your rates are right for this year? Who will run payroll and make the tax deposits on time, you or a service? And if all that sounds heavy, what would it mean for your life and your customers to have one more steady pair of hands?