Hiring Your First Employee Requires Growing Up Fast

This article, written by attorney Andrea Chatfield, was originally published by Business NH Magazine and can be found here.

When a business owner begins to think it is time to hire employee No. 1, the fledgling business is graduating into adulthood. Opportunity for growth opens up, but the business is now responsible for someone (and someone’s income) other than its owner.

Classifying Workers
The initial question will be whether or not the new person should be an employee or independent contractor. You cannot simply “make” a worker an independent contractor by paying them on a Form 1099, even if that’s what the individual wants.

Independent contractor status is something for which the worker must qualify by meeting one or more legal tests. Under Federal and NH laws, there are several tests for determining contractor status for purposes of determining income withholding tax responsibility, wage and hour laws, and coverage under various other employment statutes. The most restrictive of these tests is often referred to as the “ABC test” and is enforced by NH Employment Security (NHES) for purposes of unemployment insurance coverage.

The ABC test presumes that paying an individual for providing services to a business establishes an employment relationship. However if the individual (A) is hired for their expertise and is free from direction and control over the performance of their service, (B) is providing a service that is outside of the business’ usual course of activity (or is performed outside the business’ place of business), and (C) has their own independently established business with other customers or clients, then the independent contractor relationship is appropriate. While not a guarantee, using a carefully written independent contractor agreement can help to establish an independent contractor relationship.

If a worker is misclassified as an independent contractor, there can be a variety of negative consequences for the business – daily fines, unpaid tax liability, failure to pay proper wages and liability if the individual gets hurt on the job.

Assuming the decision is made to hire the worker as an employee, the next question is what and how they will be paid. Every employee is entitled to receive the legally required minimum wage rate (currently $7.25 per hour) for all hours worked and overtime wages when they work more than 40 hours in a work week.

Exemptions to these requirements are allowed under the Federal Fair Labor Standards Act. The most common exemption categories are the “white collar” exemptions under which the employee must be paid on a salary basis (at least $684/week, no matter the number of hours worked) and have a primary job duty that meets the requirements of one of the exemptions (Executive, Administrative, Professional). There are other industry or job function exemptions that may apply. The U.S. Department of Labor is working on revising the rules for the exemption categories, and is expected to propose raising that minimum rate in the near future.

New Hampshire, and many other States, require employers to provide employees with written notice stating their rate of pay, time of payment, and any other terms and conditions regarding their compensation. Incentive pay plans, such as bonuses or commissions, must be provided to employees in writing.

Some new employers consider offering their first employees an equity or ownership interest. While these can be effective performance incentives, they should be offered only after consulting legal counsel, and must never be offered in lieu of wages or salary to an employee.

New Hire Steps
Necessary steps to bringing on the first (and subsequent) employee(s):

  • Obtain a Federal Employer Identification Number and any applicable state or local tax identification numbers.
  • Set up a Payroll system to withhold required income taxes from employees’ wages, calculate payroll tax obligations, and ensure such monies are appropriately paid over to the IRS. The business must have a set pay day schedule (weekly, bi-weekly, etc.) and ensure all earned wages are paid on time. Many employers use external payroll services to administer their payroll.
  • Register with NHES to report all new hires (both employees and unincorporated independent contractors) and to file quarterly reports of wages and pay the unemployment tax on such wages. External payroll services can also assist with this process.
  • Obtain Workers Compensation Insurance. Failure to have workers compensation coverage on employees can result in significant fines for each day without coverage.
  • Decide what employee benefits to offer – if any. Currently, NH law does not require employers to provide fringe benefits, but if the business decides to do so, it must provide employees with written notices regarding the terms and conditions of such benefits.

When the New Employee Starts
Most employment is on an at-will basis. The term of employment is indefinite and can be terminated by either the employer or employee at any time for any reason (except an illegal one) with or without notice. Many employers use an offer letter to convey the terms of at-will employment to a new employee. If the business chooses to offer employment on a basis that is not at-will, a written employment agreement should be drafted with legal counsel.

No matter the type of employment status, employers must ensure that every employee completes the Employment Verification Process on Form I-9 and an IRS Form W-4 (tax withholding).