Employee or contractor: get this right first
This is the decision everything else hangs on, and it is not yours to make freely. The classification is determined by how the working relationship actually operates, not by what the two of you agreed to call it or what the person prefers.
The broad test is control. If you set the hours, direct how the work is done, supply the tools and materials, and the person works mainly for you, that is employment in most readings — regardless of whether they signed something saying "contractor". A genuine contractor runs their own business, sets their own methods, works for others, and usually carries their own insurance.
Getting this wrong is expensive because the liability sits with the business: back payroll taxes, penalties and interest, and potentially unpaid overtime. It is also one of the easiest things to fix in advance and one of the hardest to fix afterwards. We look at how your arrangement actually works and document the classification rather than guessing.
What you need in place before day one
An EIN, if you somehow do not have one yet. State withholding and unemployment insurance accounts, registered in the state the person will work in. Workers' compensation insurance, which most states require once you have employees and some require even earlier — the thresholds vary.
A payroll system that withholds, deposits and files on schedule. Deposit deadlines are not flexible and the penalties for missing them are automatic.
An offer letter stating pay, schedule, role and expectations. An employee handbook, because written expectations are what you rely on if performance ever becomes a conversation. A new-hire packet: tax withholding forms, employment eligibility verification, and a signed handbook acknowledgement.
The mistakes that cost the most
Paying cash. It feels simpler and it costs you twice: you cannot deduct the wages without a record, so you pay tax on money you did not keep, and the person is not covered if something happens.
Hiring with no written expectations. When it does not work out — and sometimes it will not — you have nothing to point to. A one-page offer letter and a handbook turn a difficult conversation into a straightforward one.
Assuming family is different. A cousin on the crew is still an employee or a contractor in the eyes of the state. Doing the paperwork properly protects both of you, and it prevents the kind of disagreement that is much harder to repair inside a family.
Waiting until you are desperate. Hiring in a rush, in your busiest month, with none of this ready, is how a good decision becomes an expensive one. Set it up before you need it — that is what the HR starter kit is for.
The short version
- Classification comes first — it is decided by how the work actually happens, not by the agreement.
- Misclassification is assessed against the business in back taxes and penalties.
- You need state withholding and unemployment accounts before the first paycheck.
- Most states require workers' compensation insurance once you have employees.
- An offer letter and handbook are what you rely on if performance becomes a problem.
- Family members are still employees or contractors — paperwork protects both of you.
- Set it all up before you need it, not during your busiest month.
Whitelow Legacy Group is not a law firm, an accounting firm or a registered investment adviser. This guide explains how things generally work so you can ask better questions. Rules differ by state and by situation, and anything specific to yours should go past an attorney or a CPA.
Frequently asked questions
Do I need workers compensation for one employee?
In most states, yes — the threshold is commonly one employee, though some states set it higher and the rules around contractors vary. It is one of the first things to confirm for your state, because operating without required cover is both a penalty risk and an uninsured injury risk.
Can my first hire be a 1099 contractor?
Only if the relationship genuinely is a contractor relationship — they run their own business, set their own methods, and work for others too. If you are setting their schedule and directing the work, that is employment regardless of what the agreement says, and calling it otherwise is the expensive mistake on this list.
What paperwork does a new employee have to complete?
At minimum, federal and state tax withholding forms, employment eligibility verification, and your handbook acknowledgement. There may be state-specific notices on top depending on where they work. We run the packet so nothing is missed on day one.
How much does an employee really cost beyond their wage?
More than the hourly rate — employer payroll taxes, unemployment insurance, workers' compensation premium, and any benefits you offer. The total is meaningfully above the wage, and it is worth modelling before you hire rather than discovering it on the first payroll run.