Household employees are a great plot device in television shows. Armed with the background of a hired nanny or housekeeper, writers can devise all sorts of wacky hijinks between characters from vastly different backgrounds and with wide ranging opinions. How else can you have a British butler interact with a Midwestern family?
In real life, household employees are not just for sitcoms anymore. In many of today’s two-earner families, household employees are a necessary resource to make the household run smoothly (or run at all!). But families that employ household employees do not want to be hit with an unexpected and significant tax bill, or worry that such a bill could be coming any day.
This is a realistic prospect for many families. According to a recent article appearing in the San Francisco Chronicle, an estimated 80 to 95 percent of families who hire household employees do not correctly pay or withhold taxes on the wages paid to those employees. With that kind of error rate, you can be sure that IRS agents, if they determine that a taxpayer has a household employee, will check for compliance with the tax rules on paying household employees.
We believe that many families who employ household employees, but don’t properly pay or withhold taxes on the wages of those employees, do not set out to be tax scofflaws. Many simply are not aware of the rules and don’t have the time to look them up. Even if they did look them up, many of those families do not have enough familiarity with tax laws to take comfort that they found the correct answer.
In light of this uncertainty, this article is intended to serve as a quick and easy summary, in question and answer format, of common tax obligations for families who hire household employees. Here are several things that families with household employees need to know:
- Do I have a household employee?
A household worker is often classified as an employee if you can control not only what work is done, but how it is done. If only the worker can control how the work is done, the worker is generally not your employee but is self-employed.
For your reference, a self-employed worker usually provides his or her own tools and offers services to the general public in an independent business. A worker who performs child care services for you in the worker’s own home is generally not your employee. In addition, if an agency provides the worker and controls what work is done and how it is done, the worker is generally not your employee.
If the worker is your employee, it does not matter whether the work is full time or part time or that you hired the worker through an agency or from a list provided by an agency or association. It also does not matter whether you pay the worker on an hourly, daily or weekly basis, or by the job. You will likely have tax withholding and payment obligations.
- Do I need to verify that the household employee is legal to work in the United States?
When you hire a household employee to work for you on a regular basis, you and the employee must complete the U.S. Citizenship and Immigration Services (USCIS) Form I-9, Employment Eligibility Verification. No later than the first day of work, the household employee must complete the employee section of the form by providing certain required information and attesting to his or her current work eligibility status in the United States. You must complete the employer section by examining documents presented by the household employee as evidence of his or her identity and employment eligibility. Acceptable documents to establish identity and employment eligibility are listed on Form I-9.
You should keep the completed Form I-9 in your own records and need not submit the form to the IRS or any other government or other entity. The form must be kept available for review upon notice by an authorized U.S. Government official.
- Do I need to withhold and pay Social Security or Medicare taxes?
If you pay wages of $1,800 or more in 2013 to any one household employee, then you are required to withhold and pay Social Security and Medicare taxes (FICA). This does not include wages you pay to your child under the age of 21, your parent, or an employee under the age of 18 at any time in 2013.
These taxes are 15.3% of wages. Of this amount, your share is 7.65%. Your employee’s share is also 7.65% (although you can choose to pay this yourself and not withhold it).
- Do I need to pay federal unemployment tax?
If you pay total wages of $1,000 or more in any calendar quarter of 2013 to household employees, you likely need to pay federal unemployment tax. This tax is 6% of wages, up to the first $7,000 of wages per employee. Wages over $7,000 a year per employee are not taxed.
- Do I need to pay state unemployment tax?
Under Nebraska law, if you pay wages of $1,000 or more in a calendar quarter for services performed in a private home, you will generally be required to pay Nebraska unemployment tax. The taxable wage base for 2013 will be $9,000. This means you pay unemployment insurance combined tax on the first $9,000 of wages paid to each employee each year. The $9,000 taxable wage base is set in statute and so will remain at $9,000 every year for the foreseeable future.
Nebraska’s tax rate varies based on a number of conditions. For more information on Nebraska’s unemployment tax, you can visit the Nebraska Department of Labor’s website or feel free to contact a member of the McGrath North tax group.
Other states have their own tax rates and obligations, which household employers in those states will need to research and meet.
- Are there any tax breaks for paying household employees?
The good news is that there often are tax breaks that can largely or completely offset the payroll tax obligations of an employer. Most families who hire a tutor, personal attendant, nanny, or housekeeper, whose duties include providing for the protection or well-being of a child or dependent, are eligible for the following tax breaks:
1. The Child and Dependent Care Tax Credit.
Household employers can claim a 20% tax credit on care expenses. This credit is allowed on up to $3,000 of expenses for one child and up to $6,000 of expenses for two or more children.
2. The Dependent Care Flexible Spending Account.
Many employers allow employees to contribute up to $5,000 annually to a Flexible Spending Account (FSA). Paying nanny taxes qualifies as an allowable childcare expense. Therefore, families can pay these employees using tax free dollars.
- Are there compliance requirements?
You bet. Certain key requirements, both federal and state, for household employers are as follows:
1. Register for state and federal tax accounts.
Household employers generally must apply for a state tax account and receive a tax identification number for paying and reporting employment taxes on their household employees. (Some states require multiple accounts.) The IRS has a similar procedure for reporting and paying federal employment taxes.
2. File a State New Hire Report.
Each state requires household employers to file a report detailing identification and key employment information for every new employee.
3. Determine and track payroll expenses for each pay period.
Required federal and state taxes must be withheld and itemized at each pay period. Household employees should be given a paystub which shows gross pay, net pay, and the taxes withheld.
4. Prepare state tax returns on the prescribed schedule and pay the required employee and employer taxes.
All states require that household employers pay the taxes which they have been withholding from their employee’s pay, along with the state taxes imposed on the employer. Returns are typically filed on a quarterly basis and both payments and returns are due by the end of the month after the calendar quarter. This can vary by state.
5. Prepare federal tax returns on the required schedule and pay the required employee and employer taxes.
Under IRS rules, federal employment taxes for household employers are generally remitted using the process for paying personal estimated taxes. Estimates are due four times per year: mid-April, mid-June, mid-September, and mid-January. Payments due include the federal income, Social Security, and Medicare taxes withheld from employees and the employer’s federal unemployment insurance, Social Security and Medicare taxes.
6. Prepare tax documents at year end.
This includes preparation of a Form W-2 for household employees, as well as certain filings made with the Social Security Administration. Household employers should also file a Schedule H with their personal tax return, summarizing their employment activity and tax liabilities for that year. Some states also require year-end filings from household employers.
7. Monitor employment law, including thresholds, regarding household employees.
Both the IRS and state agencies require household employers to keep up with these changes and act accordingly.
- Why do all this?
The tax payments and recordkeeping reviewed above is the law. Household employers who do not file and pay employment taxes can be subject to a maximum fine of $25,000 and potentially up to one year in jail.
The IRS and federal Department of Labor have recently collaborated to enhance enforcement of worker classification matters. The domestic industry – including household employees – was listed as a primary target of the enhanced enforcement effort. To assist taxpayers in complying with the law, the IRS also introduced the Voluntary Classification Settlement Program (VCSP), which allows employers to voluntarily reclassify their workers as employees for tax purposes – with partial relief from tax liabilities and penalties for prior periods. We have previously discussed the VCSP program in a prior newsletter.
- What should I do?
You should strongly consider entering into an employment agreement with your household employee. The agreement may address your tax obligations, as well as other legal issues involved with hiring household employees. These legal issues may include length of employment, severance pay, liability, and defining the employee’s tasks. Feel free to contact a member of the McGrath North tax group for help in drafting such an agreement.