When your freelance business is bustling and you can see additional growth on the horizon you may start considering whether it’s time to expand your team by hiring an employee. While visions of the relief having another set of qualified hands (and brain cells) at your disposal may play through your mind, it’s equally important to spend some time envisioning how this change will impact your business financially—because it will.
Ready to hire? Ready your bank balance for these higher costs. If you’ve ever been a W-2 employee yourself, you may have an inkling of what it costs to have an employee on a company payroll, beyond the obvious salary obligations. A rule of thumb is to assume at least 10 to 12 percent above the base pay that you are offering to account for matching contributions to Social Security, Medicare and unemployment insurance. In addition you’ll need to budget for workers’ compensation insurance and any benefits such as vacation, 401(k) matching or health insurance you want to provide.
As you can see, adding an employee also means adding significant expenses that will impact your bottom line. This checklist will help you identify all of the factors you need to consider when calculating the true cost of hiring an employee:
You may already have an employer-employee relationship in the IRS’ eyes. To avoid fines and penalties, it is critical to classify your team according to IRS rules. If you use contractors on a regular basis then you need to make sure you classify them correctly when it comes to their employment status. The IRS uses a comprehensive test to determine who is an employee and who is an independent contractor. You can find the IRS guidelines on contractor vs. employee classification here.
Worker classification issues are an area of particular focus for the IRS and complying with the rules is essential for avoiding penalties and fines. If you need help understanding the tax rules related to independent contractors versus employees, reach out to CPA or tax professional.
Financial preparation is key to the successful expansion of your team. Hiring your first employee is an exciting rite of passage for many freelance business owners who are ready to take the next step in growing their companies. The checklist above can help you be fully prepared for both the opportunities—and the financial obligations—that come with the expansion of your team.
Jonathan Medows is a certified public accountant licensed in New York, New Jersey, Maryland, and Pennsylvania. He is also a recognized expert in taxation for freelancers and the self-employed—often tapped for his expert knowledge and perspective on self-employment taxation by national and regional publications such as The New York Post, BusinessWeek, Forbes taxation blog, WebCPA, CPA Practice Advisor, and others. You can read some of Jonathan’s press coverage here.
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