Lumiere's Guide to Implementing Payroll

Things to consider before you make your first hire.

Congratulations! Your business is growing and you’ve decided to hire your first employee. You have found the perfect person and agreed on compensation but where do you go from there?

You must now tackle onboarding, establishing benefits, becoming compliant, and configuring and running a payroll platform. This may sound overwhelming, but don’t worry, we’re here to help. In this guide, Lumiere will step you through our process for hiring your first employee so that, right from day one, they’ll be ready to contribute to your business’ success.

Here is our guide to getting started.

1. File for Your EIN (Employer Identification Number)

Your EIN is also known as your Employer Tax ID, and you’ll use this for filing your employment and other taxes with state and federal governments. Before applying for a federal employer identification number (EIN) you should have already formed an entity. Most business owners elect to establish a structure beyond a sole-proprietor to establish liability protection. The most common corporate entity types for small businesses are S Corporations and LLCs:

S Corp

An S Corporation (“S Corp”) is a popular choice for many businesses because profits, losses and other tax items pass through the corporation to the shareholders. Although they can be more complicated legally, they can provide significant tax savings. S Corp owners who perform more than minor services for the organization are required to be reasonably compensated as employees as well as owners.

LLC

A Limited Liability Corporation (“LLC”) is a lightweight alternative to incorporating your business and is similar to an S Corp as it provides the pass-through benefits of the S Corp entity. LLCs are generally less complicated legally with fewer state-imposed annual compliance requirements.

See also the U.S. Small Business Association Guide to Business Structures

After you determine your corporate identity, you’ll need to apply for an EIN directly through the IRS. (Note: sole proprietorships do not need a EIN, but partnerships do). The IRS also has an helpful guide to Establishing Your EIN.

Check which EIN state requirements are applicable to you. While you are at it, you should also Enroll in EFTPS to see what payments your payroll company is making on your behalf

2. Register With the Relevant State Departments

You will need to register your company with the compliance department for every state you employee people in. Some states can have up to three departments that handle compliance with state tax collection, unemployment, disability, etc..

In California, the Employment Development Department (EDD) handles both tax collection and labor and workforce laws like unemployment. To register as a new employer in California you will need to complete the following:

• Enroll as a New User through e-Services for Business at the EDD site.

• After you have enrolled, access your e-Services account to apply for an Employer Payroll Tax Account Number.

• Complete the registration process. You will be asked for information about your business and its operations in California including your California Secretary of State number. You can search for it here.

• The EDD may take up to 3 business days to complete processing.

3. Establish Insurance

Caring for your team by offering health, retirement and other benefits helps employees and their families stay healthy and financially secure. As a small business owner, there are a number of types of insurance you must have and a number you also should have.

• Workers Comp - A state-regulated program that covers job-related injuries and illnesses including wage replacement if they’re unable to return to work. Premiums vary by industry and job classifications. Every state has its own set of workers’ compensation rules. See the National Federation of Independent Business (NFIB) summary of each state’s policy.

• Disability Insurance - Provides short-term Disability Insurance (DI) and Paid Family Leave (PFL) wage replacement benefits to eligible workers who need time off work due to illness or injury, pregnancy, or childbirth or to care for a seriously ill family member or to bond with a new child. California provides this through the California State Disability (SDI) program.

• Employment practices liability insurance (EPLI) - Provides coverage to employers against claims made by employees alleging discrimination, wrongful termination, harassment, or other employment-related issues.

4. Document Employees

To protect themselves from potential litigation and avoid confusion, companies should utilize Job Descriptions, Offer Letters, Employment Agreements and Employee Handbooks. These will help establish policies and details of the role, compensation, and other legal ramifications of the position when hiring an employee or contractor including:

• Wage and hour including overtime

• Leave including vacation, pregnancy, paid family leave, etc.

• Harassment and discrimination

• Fringe benefits (commuter, meals, etc.)

5. Collect and Maintain Employee Information

Maintaining accurate and up-to-date profiles for your employees is crucial. For each new hire, besides the basic name, date of birth and address, be sure you keep the following data available and secure:

• Employment start date.

• Compensation details in writing to prevent later disputes (including any changes to compensation or responsibilities).

• A W-4 for employees (or a W-9 for independent contractors).

• An I-9 Form to verify employees’ eligibility for employment in the US, and the verification documents.

See Also Doing Business In California - A Guide for Employers

6. Classify Employees

You need to know if your employees are exempt or non-exempt from overtime pay, and if you will be withholding taxes or paying them as a independent contractor. The federal guidelines for exempt employees can be complicated, and mistakes can be expensive. Before you make this important staffing decision you need to fully understand both types of workers and the importance of classifying them correctly. Failing to do so could cost your business.

Here are some general guidelines:

Contractor	Employee
Hired for temporary project	Eligible for company sponsored benefits (insurance, retirement, PTO)
Chooses where and when the work is performed	Eligible for unemployment and workers compensation
Uses their own materials for the work performed	Has local, state, and federal taxes withheld. Company contributes to Social Security and Medicare
Paid a flat fee or hourly rate that is invoiced to the company	Could be eligible for overtime pay depending on job function and hours worked
Conducts similar business with other clients besides company	Works solely with one company

If you are still unclear, complete IRS Form SS-8 and they’ll give you a final determination of the worker’s status. It could take 6 months for a decision, but it will give you peace of mind to continue running your business.

Check out Lumiere’s Guide - Employee vs Contractor, Exempt vs Non-exempt - Determining Worker Classification for more information.

7. Pick and Implement a Payroll Platform

Pick a platform that is scalable and meets your particular business needs. Payroll is no place to take shortcuts, the penalties and difficulties that come with errors and poor timing are too high.

Every platform handles general payroll management tasks (direct deposit, multiple wage rates, garnishment payments, PTO, etc.) Some other things to considering when selecting a payroll platform:

• Employee self-enrollment: Will the solution allow your employees to provide their onboarding information, view pay stubs and pull tax forms on their own?

• Integrations: Does the solution integrate directly with your accounting software, automatically coding to account and department?

• Tax liability management: As an employer, you need to withhold, report and remit Federal Withholding, State Withholding, Local Withholding, Federal unemployment (FUTA), and State unemployment (SUTA). The IRS created a guide. One of the benefits of a payroll solution is they automatically file and remit your payroll tax liabilities for you.

You should also consider implementing a solution for the following

• Tracking employee’s hours, PTO, and sick time

• 401K employee contributions or employer matching

• Expense reimbursements, commissions, bonuses, etc.

There are dozens of options for payroll software, and selecting yours means finding the one with the features you need at a price that works. Lumiere has experience working with many of the top recommended platforms.

Finally - Address Backups and Disaster Recovery

Not only is it a best practice to have backups and copies of important records in the event of a disaster, the IRS requires you provide evidence to substantiate entries, deductions, and statements made on your tax returns. You must be able to prove certain elements of expenses to deduct them and for most businesses payroll is their largest expense. It is also important to have I-9 forms, W-2s, new hire forms, and copies of all your filed tax forms (Form 941, Form 940, and state tax forms) available.

Employee vs Contractor, Exempt vs Non-exempt - Determining Worker Classification

Determining whether members of your workforce should be classified as employees or independent contractors can be difficult. The rules both the IRS and the states have established to determine their status are confusing and if you classify them incorrectly, there can be significant fines. Additionally, once a worker is established as being an employee, they are further designated as being exempt or nonexempt as it applies to the ability to receive overtime pay and other employee benefits.

Lumiere has put together the following guide to help answer many of the questions you might have when classifying your resources.

Independent Contractor (Self-Employed) or Employee?

One of the most critical distinctions a business owner will have to make is whether their resources are independent contractors or employees. Besides the compliance issues, this designation determines who pays the employer taxes which are almost 8% (6.2% for social security is 6.2% and 1.45% for Medicare)

Some key differences that establish a resource as a contractor:

• They determine their schedule, time frame for completing, work location.

• They do not participate in employee benefits from the employer.

• They are ineligible for unemployment in the event of a layoff or termination.

There are some downsides for workers that are classified as contractors

• They are responsible for all expenses incurred while completing the job.

• They are not protected by anti-discrimination and workplace safety laws

• Unless a contract states otherwise, they can be terminated at any time, for any reason.

In determining the categorization of a worker, at question is the degree of control the company holds over the resource and level of independence the resource has across three factors :

• Behavioral: Who determines what the worker does and how the worker does his or her job?

• Financial: Who controls the economic aspects of the resources job? How is the worker paid, are expenses reimbursed, do they provide their own tools/supplies, etc?

• Relationship: Do contracts exist between the worker and company, does the worker have other clients, are there any employee benefits ( pension, insurance, vacation, etc.) for their work?

• Companies should weigh all of these factors when determining whether a worker is an employee or independent contractor. While some factors may indicate that the worker is an employee, other factors can indicate they are an independent contractor. There is no “magic” or set a number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination.

The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.

Form SS-8

If, after reviewing the three categories of evidence, it is still unclear whether a worker is an employee or an independent contractor, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding (PDF) can be filed with the IRS. The form may be filed by either the business or the worker. The IRS will review the facts and circumstances and officially determine the worker’s status.

Be aware that it can take at least six months to get a determination, but a business that continually hires the same types of workers to perform particular services may want to consider filing the Form SS-8 (PDF). 

Misclassification of Employees

There are significant consequences of treating an employee as an independent contractor. If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes (withholding and social security) for that worker See Internal Revenue Code section 3509 for more information.

Use this chart to help you properly categorize your workers:

Item	Employee	Contractor
Employment Laws	Covered by a number of federal and state employment and labor laws	Not covered by employment and labor laws
Hiring Practice	Applicant receives a job offer. After a person accepts the position, the employer must ask for additional information about the employee such as date of birth, marital status, and citizenship status	Interacts with the person or department that needs the service completed. A contractor typically provides a proposal and enters into a contract with the legal or procurement department of the business.
Tax Documents	Provides name, address, Social Security number, tax filing status, and number of exemptions on a W-4	Provides name, address, Taxpayer Identification Number, and certification about back up through a W-9
Payer’s Tax Reporting Requirements	Reports all money paid to the employee during the tax year on a W-2	Reports payments of $600 or more in a calendar year on a Form 1099
Reporting to Other Agencies	Reports for state and federal Unemployment Insurance	None
Value of Work or Contract	Earns either an hourly rate or a salary	A contract may be for a total amount, an hourly, daily, or weekly amount that ends on a specific date or a total amount to be paid when the job is completed
When Paid	Federal and state laws require that an employee be paid on the normal pay date or earlier if the paycheck is not negotiable on the normal pay date, which can occur on holidays	Accounts Payable pays a contractor after receiving an invoice. The contract dictates when payments are made, such as upon completion of a task or by periodic amounts

Exempt vs. Nonexempt

After you have determined that your workers are employees, you will need to determine if they qualify for overtime wages when they work over 40 hours per week. The differences between nonexempt and exempt employees have been established by the Fair Labor Standards Act (FLSA). The FLSA sets basic minimum wage and overtime pay standards and regulates the employment of minors. The FLSA does not regulate vacation, holiday, severance, sick pay, holidays off, or holiday pay among other things.

Employees that are classified as exempt typically perform job duties considered professional, executive or administrative. The US Department of Labor has a list of the more commonly used exemptions

California Rules

California also follows the three simple requirements to determine whether a worker is an exempt employee under California law:

1. Minimum Salary. The employee must be paid a salary that is at least twice the state minimum wage for full-time employment regardless if it is a salary or calculated hourly.

2. Managerial Duties. The employee’s primary duties must consist of administrative, executive, or professional tasks. Their job title is irrelevant.

3. Independent Judgment. The employee’s job duties must customarily involve the use of discretion and independent judgment while comparing and evaluating possible courses of action and making a decision after considering various possibilities.

If these three requirements are met, the employee will usually be classified as exempt from overtime, minimum wage, and rest break requirements (but not meal break requirements). There are, however, many caveats to this test. Some jobs that are subject to a different test altogether and some employees are only partially exempt; meaning, they are protected by certain labor laws, but not others. The State of California Department of Industrial Relations has provided guidance for exemptions from the overtime laws.

Take Employee Classification Seriously

Misclassification is one of the most common causes of lawsuits against employers, and it is not surprising to learn that regardless of the employer’s size, many have had to pay large amounts of money for misclassifying employees.

Lumiere’s recommends that employees treat worker classification seriously. Employers who maintain a cavalier attitude when addressing employee/contractor and exempt/non-exempt classifications could find themselves burdened with liabilities for fines, unpaid wages, interest, penalties, and most likely - attorney fees.