Quick Guide: How To Pay Employees At Your Startup
Wow. That is great news that you are ready to hire someone to help you build your company! There are a couple of ways that you can pay people when starting out, which are pretty easy to set up. I think the most important thing here is to understand the basics of paying people and what the advantages and disadvantages are for each one. Then you can decide what is best for you at the this time.
Full time employee vs contractor...which is better?
Well, neither is better than the other. It would be great to live in a world of black and white to say this is good and that is bad, but unfortunately life just isn’t that simple.
The main difference is that for a full time employee you will need to:
- Pay employer paid taxes on top of the employee’s salary (estimate about 8%)
- Calculate the employee’s portion of their income taxes
- Submit the employer and employee taxes to the appropriate tax authorities
- Issue a W2
For a contractor, you just pay them according to the terms of your agreement. The contractor will have to calculate and submit their own taxes as well as pay the employer portion of the taxes. (That is one reason why contractors will charge more than you would pay a full time employee.) For a contractor you will need to:
- Collect the contractor’s W9
- Issue a 1099
Just from the number of bullet points, you can see that the contractor is way less work for the employer. But let’s understand the advantages and disadvantages of each a little better.
Advantages of hiring a full time employee:
- They work directly for you (you have more control over their work)
- They are more likely to be invested in your business
Disadvantages of hiring a full time employee:
- There is a lot of paperwork - I9, work authorization documents, W4, state set up, tax payments, workers comp insurance, W2s
- Categorizing the employee as exempt vs nonexempt (Essentially, does this person need to get overtime according to the law?)
- Terminating an employee can be costly (not only is there a risk of being sued, but also your state unemployment tax rate increases)
- You may need to offer health insurance benefits depending on the state and size of your company.
For full time employees you will also need to have them sign an offer letter, which describes the terms of employment. Most US companies offer “at will employment” to employees, except for high level executives. “At will employment” means that the employee or employer can terminate the employment with or without any reason or notice. This technically should reduce lawsuits for unlawful termination. (I’m not sure if it does, there are a lot of savvy ambulance chasers these days).
Advantages of hiring a contractor:
- You don’t get too bogged down with paperwork and laws (hopefully)
- Low / No commitment: the terms are flexible
- You can set up agreements that can be terminated with little to no notice
Disadvantages of hiring a contractor:
- They are not your employee. Some companies (perhaps your prospective clients) won’t work with companies who have contractors working on their team.
- The flexibility goes both ways: the contractor leave you stranded with no recourse
With a contractor essentially you sign an agreement regarding the work and payment terms and the contractor must provide a W9. Then you pay the contractor based on the invoices they submit and the agreed upon payment terms. At the end of the year you issue a 1099, which is a summary the total amount paid to this person.
One law that you should note when hiring contractors is that contractors are supposed to be independent from the company. Essentially you are not supposed to give them training and have them behave in a way that a full time employee would. This is what Uber has been sued for. Why would Uber categorize drivers as contractors instead of employees? Simple. It is cheaper.
Ok, so how do you get these people paid?
Hire A Contractor
Either you or the contractor will create an agreement with the scope of work, deliverables, timing, costs and payment timing. Once this agreement has been signed, collect the contractor's W9 form. The W9 form has the person’s federal tax classification type, their tax ID number and address. If the W9’s federal tax classification is anything except a C Corp or an S Corp, at the end of the year you sum what you paid the contractor and fill out the 1099 form. The 1099 has three copies: send one to the IRS, one to the state and one to the contractor. Note that if you paid the contractor less than $600 in that year, you do not need to file the 1099 form. If the contractor's business is a C Corp or an S Corp you do not need to do anything, although it is unlikely for a contractor to set up their business as a Corp or an S Corp.
Hire An Employee
When you hire an employee you essentially have two choices: calculate and pay the taxes yourself or outsource it. I would highly recommend outsourcing it. Especially if your company is small, like less than 20 people.
Manage Payroll Yourself
If you happen to know how to calculate and pay payroll (I’m not sure why you have read this far) you can manage this through Quickbooks Payroll. Essentially you gather the information about city, state and federal taxes rates and due dates by calling up each tax authority. Then enter the info into the system and Quickbooks Payroll will deduct those amount from the employee’s payroll amount. You can pay them employee by printing a check or paying via ACH, which your business bank account should offer.
If you are running a small business, you probably do not have the time to manage all of these details to run payroll. The most annoying part is the tax payments that you need to submit. Each tax authority has a different due date and form of payment (check vs ACH or wire) which typically depends on the entire liability. For example, if you owe the IRS $100 thousand or more (go you if you have been able to build up your company to that level), the payment is due the next business day after payroll. But others may be due annually, quarterly, monthly, biweekly or on random dates.
Unless your business is a payroll business or some type of accounting business and you have too much pride to outsource your payroll, you are better off outsourcing it.
There are a ton of payroll companies that you can hire to do your payroll. After setting up an employee, which includes providing their name, address, social security number, W4 info and bank account, if they will get direct deposit, you can easily pay employees. Most services allow you to call in the payroll a couple of days before you want to pay the employee or you may be able to do it through their online portal.
I have worked with ADP and Paychex and they are both fine. The customer service is not amazing because when your account is so small they will not assign you your own account manager, you get pushed around to many different people. Also, they make mistakes easily since there isn't just one person looking out for you. I have had ADP pay people twice because of this.
That being said, they will get the job done. They will pay your people on time, submit the taxes and issue your W2s. And if they make a mistake in any of those areas at least you have some recourse and can get them to fix your problems instead of doing it yourself. Good luck and congrats on the hire!