Helpful Advice on Taxes and Benefits
Tax withholding and benefits administration are often among our clients’ greatest administrative concerns. The IRS defines a household employer as someone who pays an individual to perform duties in or around their home and controls when, where, how or by whom the work should be performed. Household employees include nannies, medical caregivers, housekeepers, chefs, personal assistants, household managers, etc.
For this, we encourage clients to consult a qualified tax professional or IRS Publication 926 Household Employers Tax Guide. Additionally, we can make recommendations regarding domestic tax and payroll services.
Here is some essential information to build your base of knowledge on the topic. The most common points of misunderstanding surround employment status and the wage & overtime rules.
- Employee vs. Contractor – To simplify administration, some families and domestic staff choose to engage in a client /Independent contractor relationship, with the worker filing income as a 1099 independent contractor. The perceived benefit to the family is that the worker is theoretically treated as an outside self-employed proprietor, responsible for her own taxes and insurance. The family just “pays the bill”.
Unfortunately, the decision as to whether or not the worker may file as a contractor is not at the family or employee’s discretion. Independent contractor status is defined by the nature of the relationship, and rarely do domestic work arrangements qualify unless the worker can demonstrate sufficient independence and expertise. For example, does the worker have a license, business card, multiple clients, freedom to perform his or her duties and authority to make decisions without the family’s involvement or supervision? Does the worker use his or her own equipment to perform the work?
Rarely are these requirements met completely, and if the worker or family is ever audited or the worker ever files for unemployment or social security benefits in the future, the nature of employment may be reviewed and corrected, with penalties levied on both parties.
- Business vs. Household Payroll – Families who own a business are sometimes tempted to include their household employee within the company’s payroll and tax reporting process. This could potentially be expensive and has been held to be illegal. The IRS has ruled that household employees are not direct contributors to the success of the business and therefore, should be handled through the household payroll and reporting process.
- Wage & Overtime – Per the Fair Labor Standards Act, you are required to pay overtime of 1.5 times the regular hourly rate for a household employee who does not live with you, and works over 40 hours in a 7-day work week. If a household employee works more than 40 hours in a week and is paid a salary, overtime should be included in the salary computation. Live-in employees are subject to different overtime treatment and requirements vary by state. Some states also have special guidelines regarding how overtime should be calculated.
While we do not enforce the tax rules, we do our best to inform clients so they make the best decisions for their situations. We also offer to assist with work agreements and other new hire paperwork to get employers and employees off to a positive start based on a clear understanding of their compensation and job duties.
The Hazel Agency offers the following counsel on benefits:
- Vacation: The standard is two weeks. Some people offer their employees a week of vacation after six months, and another week at the end of one year of employment. You also may require your employee to take one week of vacation when the family takes its vacation, and the other week at his or her discretion.
- Holidays: Most household employees get all major holidays off, New Year’s Day, Memorial Day, 4th of July, Labor Day, Thanksgiving and Christmas. Your employee may wish to negotiate other days as well as certain religious holidays.
- Sick days: If your household employee has a bad cold or other highly communicable illness, you most likely do not want her around your family. Paid sick days are an incentive to stay away and recuperate. Some employers provide up to five paid sick days a year. Base your policy on your generosity and ability to identify temporary assistance for sick employees.
- Health Insurance: Many household employees do not have health insurance, so this may be an added incentive for hiring. If you decide to provide this to your employee, you may elect to split the premium with him or her, or offer it instead of a higher salary. In addition, employer contributions to the employee’s health insurance are non-taxable to both the employer and employee.
Other things you may wish to provide:
- Car insurance
- 401(k)/retirement plan
- Continuing education (CPR, First Aid, National Nanny Training Day, etc.)
Frequently Asked Questions
Q. What is required to become a household employer?
A. A household employer needs a Federal Employer Identification Number (FEIN) from the IRS, along with the applicable state and local tax accounts that are required. In addition, as payroll begins, the appropriate payroll taxes are withheld from the employee’s pay checks.
Q. What are nanny/household payroll taxes?
A. Nanny and household payroll taxes are the employee and employer taxes that are due to the government as a result of having a household employee. Taxes vary by locality, but typically, these taxes will include Social Security and Medicare, federal and state income taxes, and federal and state unemployment insurance. In certain localities, other state and local taxes also might be due.
Q. Why should I pay nanny/household taxes? Are they required?
A. As a household employer, you are required to report and pay in all the payroll taxes applicable to your locality and employment situation. Social Security and Medicare taxes apply when a household employee will earn $1900 or more during the calendar year. In addition, state unemployment insurance taxes must be paid when your state’s threshold is reached, which is typically $1000 gross wages paid in a calendar quarter.
Q. What employee taxes need to be withheld from my employee’s pay checks?
A. Social Security and Medicare taxes (7.65%) need to be withheld if the employee earns $1900 or more during the year. Income tax withholdings are optional for a household employee, but highly recommended, so the employee does not owe a large amount of taxes on their yearly returns.
Q. When do I start withholding taxes from my employee’s wages?
A. Taxes are withheld from the first day of employment, and should be reflected on the first pay check issued.
Q. What are my employer tax responsibilities?
A. The employer must match the amount of Social Security and Medicare withheld from each payroll check. This “match” is 7.65% of the employee’s gross wages. The employer also pays federal and state unemployment insurance taxes. In some situations, additional state or local taxes will be due. Total employer taxes typically run about 10-12% of an employee’s gross wage.
Q. Are there other employer requirements?
A. The employer needs to report every new hire to the state. There also are monthly, quarterly, and/or yearly reports that need to be filed with your tax payments. In addition, a W2 form should be issued to each employee, year-end forms need to be filed with the state and Social Security Administration, and a Schedule H needs to be filed with your personal income tax return.
Q. What is worker’s compensation insurance?
A. Worker’s compensation is an insurance policy that protects you if your employee is injured on the job, and makes a claim for lost wages and/or medical expenses. Each state administers their own worker’s compensation system, and the requirements vary. Some states require that you have a policy, while others make it voluntary. In the state of Georgia, it’s voluntary. If you want to obtain a policy, please contact your homeowner’s insurance agent first. In some cases, an umbrella homeowner’s policy may already cover your employee, or they may be able to add a rider to your existing policy.
Q. Are there any benefits to the employer or tax credits for paying nanny/household taxes?
A. Household employers who pay their employee legally may have tax benefits available to them.
- Some companies offer a Dependent Care Account that allows an employee with child or dependent care expenses to contribute up to $5,000 of their pretax earnings. This also is known as a Flexible Spending Account. The funds in this account are used to pay for childcare expenses tax-free.
- If a Dependent Care Account is not available, the employer may be able to claim a tax credit on their personal income tax return through Form 2441-Child and Dependent Care Expenses. A tax credit of 20 to 35% is available on qualifying childcare expenses, which are limited to $3,000 for one qualifying dependent or $6,000 for two or more qualifying dependents.