I have been advising small businesses, including startups, for a long time now on all types of legal issues. Recently a client asked me a question that I had never been asked in that way before. He said that he was about to hire his first employee. What legal steps should he take? What a great question I thought. Probably many people would like to know the answer. So I wrote this blog article. This is intended as only a brief overview (I am not good at brief, but I will try). You should talk to your own attorney about these issues as they come up.
1. Incorporate before you hire
If you have not already done so, you should incorporate before you hire someone,. A corporate entity provides a shield from liability for the individual owners. Contrary to common belief you are not shielded from liability for your own negligent acts. However you are shielded from liability for acts of your employees. Let’s say you send an employee out to deliver something to a customer. On the way back, the employee stops at a bar and gets drunk before returning to the office. Then he causes an accident seriously hurting or killing someone. Your incorporated company may be liable, but generally you will not be personally liable.
There are many different types of legal entities. The three most popular are the ‘C’ corporation, the ‘S’ corporation (the letters refer to the labels for certain paragraphs in the Internal Revenue Code), and the limited liability corporation (’ LLC’.) I think the ‘S’ corporation and the LLC are both overrated for reasons I will not get into here. I usually recommend incorporating as a ‘C’ corporation. The ‘C’ corporation is commonly just referred to as a corporation. By default if you register as a corporation and do not elect with the IRS to create an ‘S’ corporation, you have created a ‘C’ corporation. Most of the time, you should incorporate in the state where you have your office and do most of your business. This is definitely a good topic of conversation to have with your investors, your lawyer, and/or your accountant.
2. Get an EIN
An EIN number (a bit of a redundant phrase I know) is an Employee Identification Number. It is like the social security number for individuals, but it is for a businesses. You do not have to be incorporated or have employees to get an EIN. The name is left over from days when you only got one if you had employees. You must have an EIN in order to pay federal employee taxes. Given how much indentify theft there is using stolen social security numbers, it is a good idea to get an EIN and use it as soon as you start to operate a business. These days you can get an EIN online from the IRS very easily.
3. Have a written employment agreement
Any attorney will tell you that it is always a good idea to put any agreement in writing. In an employment agreement, you could describe the company policies on sick leave, vacation, use of company equipment, whether outside employment is allowed, and use of email and social media.
If you have valuable intellectual property (IP) such as patents, copyrights, or even customer lists, you should spell out who owns what (usually the company owns all of this). In particular, if the employee will be creating IP, then you should definitely state that all such IP belongs to the company. If you put this in an employment agreement then in some states, including Washington, you must include certain very specific language. (In Washington, see RCW 49.44.140.)
You should emphasize that all employment is at-will. This is a legal term that means that you can fire the person at any time for any reason or for no reason at all. Of course, it works both ways – an employee can quit at any time as well. Even if you are hiring someone for a specific project and time period, it is always a good idea to preserve the at-will status. At least in Washington, all employment is at-will unless there is an agreement otherwise. The safe course is to put it in writing anyway. Otherwise, it is not uncommon for employees to interpret company action as promising employment for a specific period.
You may have other express or implied contracts with your employees, whether you intend these results or not. Do you have an employee handbook? Do you have company policies that affect employees? Do your actions imply a policy of treating employees a certain way? These and other factors may become part of the company’s agreements with its employees.
4. Consider non-compete and confidentiality agreements
Depending on the nature of the work, you might want to have a non-competition agreement and/or a confidentiality agreement with the new employee. These are separate issues but they are often handled together. Neither one is easy to enforce.
A non-compete agreement has to be carefully worded. You cannot simply prohibit someone from working in a particular field. You have to have a valid business reason for limiting their future work. A worker acquiring general knowledge of your industry is not enough. They have to have acquired certain specific information and skills that are unique to your company. Even then, you should define the amount of time they can not compete, the geographic area in which they can not compete, and the area of business in which they can not compete, as narrowly as possible. If your agreement is too broad in any one way, it may be totally unenforceable. It is best to have an attorney draft a non-compete agreement for you.
Unlike most areas of law, the exact wording of confidentiality agreements is not very important. Almost any statement will do. Make sure your employee knows what information the company considers confidential, and that the requirement for keeping this information confidential continues even after employment ends. If something is not confidential either because it is general knowledge or because you do not treat it as confidential, then saying that it is confidential will not make it so. Have a system in place to protect your company’s confidential information. Especially in the tech field, where confidentiality is very important, it is hard to protect information. Some courts have held that since technology information changes so rapidly, any confidential information is out of date and therefore no longer protectable in as short a time period as one year.
Watch out for the flip side as well. Ask your new employees if they are subject to any non-compete and confidentiality agreement with their former employees. Ask for copies of such agreements and let your employees know, preferably in writing, that you do not want them to violate those agreements.
5. Have employees sign contracts before they start work
In order for a contract to be enforceable, each party must give something and must get something in return, what lawyers call “consideration”. In an employment contract, the new employee agrees to certain conditions and in return gets a job. In Washington if you offer an existing employee new employment contract terms or a new non-compete or confidentiality agreement, continued employment is not adequate consideration. So if you say to an existing employee, sign this new agreement or you lose your job, and they sign it, it is not enforceable. You have to give them something new in return for their agreement to the new terms, such as increased wages, a promotion, a bonus, a fixed term of employment, or access to protected information.
6. Pay taxes
There are always taxes to be paid. There are a number of state and federal taxes specifically related to the payment of wages. Make sure you stay on top of this. Many new businesses that have only a small number of employees hire a company to pay these taxes for them. I have also seen the payment of taxes made a part of the employee’s responsibilities.
7. Avoid personal liability for wages and taxes
Anyone who has any control over the payment of wages and taxes can and usually will be held personally liable if these are not paid on time. A recent case in Washington ruled that this personal liability for wages still exists after the company goes bankrupt. If you do not learn anything else from this article, know that you should not employ anyone unless you already have the money to pay them and related taxes. If you have employees and you are running short of cash, let them go. Do not keep them onboard hoping that more money will come in. The risks of keeping them on the payroll are too great. You may be held personally liable for at least double the wages and attorneys fees and taxes and penalties. It does not matter if they agree to assume the risk of payment. If you have any control over the payment of wages and taxes you are strictly liable, pretty much no matter what.
As a reminder, you are always liable for your own negligence, regardless of the form of the business entity. If you see a safety issue, do not put it off: fix it now.
8. Post required notices
The federal government — and as far as I can tell, all states — require employers to post certain notices at the place of employment. These notices advise workers of their legal rights. Some cities and other municipalities may require notices as well. These notices are usually available for download on the Internet. These notices are often referred to as posters.
It can be hard to figure out which notices are required for a particular employer. Many of the notices are only required if your company meets certain requirements. The rules and the notice contents change often.
A good place to start to determine federal requirements is the FirstStep Poster Advisor, http://webapps.dol.gov/elaws/posters.htm. This website focuses on the Department of Labor requirements. Another good website is https://www.hr360.com/Human-Resources/Federal-Poster-Requirements.aspx.
The state of Washington has a website that lists federal and Washington state notices required in Washington: http://www.lni.wa.gov/IPUB/101-054-000.pdf. Other states may have similar websites.
9. Do not discriminate, but do accommodate
Many types of employment discrimination are prohibited in the work place. Common categories of discrimination are race, gender, religion, national origin, physical or mental disability, age, sexual orientation, and gender identity. Employment discrimination is prohibited by a complex set of federal and state laws, which often overlap, sometimes with unusual results. For example, even in states where marijuana use is now legal, it is still legal to require drug tests and not to hire anyone who uses marijuana even on their own time. Discrimination for drug use is covered by federal law, and because marijuana use is still illegal on the federal level, there is no protection for marijuana users. See an employment attorney in your state for more detailed information.
There is law prohibiting some forms of discrimination against individuals with disabilities. Most of these prohibitions are covered by the Americans with Disabilities Act (ADA). The ADA is a civil rights law that prohibits discrimination against individuals with disabilities in all areas of public life including jobs. The definition of what constitutes a disability is very broad. It is not always easy to determine if a particular individual is protected under the act. Employers are required to provide reasonable accommodations to employees and prospective employees with disabilities. What constitutes reasonable versus unreasonable accommodations is often difficult to determine. See an employment attorney in your state for more detailed information.
10. Watch out for and obey employment conditions laws
There are a number of laws that govern the conditions of employment. These include federal and state laws and in some cases city or other municipality laws. For example, the federal government requirement most types of worker to be paid a specified minimum hourly wage. The state of Washington requires payment of a higher minimum hourly wage than required under federal law. The city of Seattle requires payment of a higher minimum hourly wage than required under federal or state law. There can also be requirements for sick leave, vacation, health insurance, maternity leave, and number and length of breaks. For certain jobs there can be federal and state safety requirements. In any particular employment there may be other requirements as well. This list is only intended as a starting point.
11. Make sure independent contractors are really independent contractors
Employees are subject to various employment laws, rules and taxes. Independent contractors are not subject to many of these and are taxed differently. Government entities will classify workers according to how you treat them. Whether you call them independent contractors or not is only one factor in that analysis. In many cases, it is obvious that someone is or is not an employee. But in some cases a person is treated as an employee in some ways, and an independent contractor in other ways. In these cases, the question is are they more like one or the other. There is no one factor that determines that outcome. The answer is based on all of the relevant facts of the specific case. These factors include but are not limited to
- do you set their hours or do they?
- do they work under your direction and supervision or are they independent?
- do they work only for you or do they have other clients?
- do they work in your office and/or with your equipment?
In Washington you can find a general guide at http://www.lni.wa.gov/IPUB/101-063-000.pdf. Other states probably have similar booklets. The IRS has published various rules at various times. A general IRS guide is at https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee. You can find a lot more information on this topic by googling “independent contractor guide.”
12. Avoid the intern trap
Beware of the changing government attitude towards unpaid interns. It is common in many industries for companies to hire interns and to not pay them wages. The thought is that they are gaining valuable experience, learning particular skills and adding value to their resume. They are already being well compensated, and do not need to be paid as well. In many cases the employer receives benefit from the employment of the intern. There is a growing trend among government agencies to treat interns who do work of benefit to the company as regular employees subject to regular employment laws such as minimum wage requirements.
That covers the basics, and just the basics. Feel free to ask questions in the comments section and I will try to answer them there. Also, feel free to add comments and suggestions. Be sure to check with your local employment attorney for more detail.