Article Highlights:
- Who is a Household Employee?
- Examples of Household Employees
- Independent Contractors
- Payroll and Withholding Requirements
- Nanny SEPs
- Deductibility of Household Employee Payments
- Penalties for Non-Compliance
- Other Tax Issues
Employees of the household provide vital functions in many households, including childcare, elder care, housework, and gardening. Nevertheless, hiring domestic assistance has some obligations, especially concerning salary, withholding, and tax filing. The complexities of home employment are covered in detail in this article, including worker categorization, payroll regulations, tax ramifications, and non-compliance fines.
Who is a Household Employee?
Someone who provides domestic services in a private residence is known as a household employee. This covers caretakers such as nannies, housekeepers, gardeners, and others in a similar capacity. The primary distinction between an independent contractor and a domestic employee is the extent of control the employer has over the job produced. The worker is normally regarded as an employee if the employer specifies the type of work to be done and how it is to be done.
A caregiver who works from home is typically not employed by the parents of the children they look after. The worker is not regarded as a household employee if an agency employs them and sets the terms and conditions for their job.
Examples of Household Employees:
- Nannies and babysitters
- Caregivers for elderly or disabled individuals
- Housekeepers and maids
- Gardeners and landscapers (if they work under the homeowner's direction)
Independent Contractors:
Conversely, independent contractors run their own companies and offer services to the general market. Usually, they provide their own equipment, decide how the work will be done, and establish their own hours. When they work for you in your own home, they are not considered domestic employees and are not subject to reporting obligations. As examples, consider:
- Plumbers
- Gardeners and landscapers (if they don't work under the homeowner's direction)
- Electricians
- Pool maintenance workers
- Freelance landscapers
Payroll and Withholding Requirements
When you hire a household employee, you become an employer and must adhere to specific payroll and withholding requirements. Here are the key steps involved:
- Employer Identification Numbers (EINs): You must get an EIN from the IRS, both federally and, in certain situations, state-wide.
- Form I-9: To confirm an employee's ability to work in the United States, both the employer and the employee must complete Form I-9.
- Employers are required to submit Schedule H, together with their federal income tax return (Form 1040), to disclose household employment taxes. Schedule H includes FUTA, any withheld federal income tax, Social Security and Medicare taxes.
- Social Security and Medicare Taxes :Together with paying the employer's portion of these taxes, you are required to deduct Social Security and Medicare taxes from your employee's income. In 2024, the employee's and employer's Social Security tax rates will be 6.2% and 1.45%, respectively, for Medicare.
- Federal Unemployment Tax (FUTA) : If you provide your home employee $1,000 or more in a calendar quarter, you can also be required to pay FUTA tax. For each employee, the first $7,000 in pay are subject to a 6.0% FUTA tax rate.
- Income Tax Withholding: Federal income tax withholding is not required for household employees unless both the employer and the employee agree to it. However, it is advisable to withhold federal income tax to help the employee avoid a large tax bill at the end of the year.
- State Employment Taxes: State requirements vary, but you may need to pay state unemployment insurance and disability insurance taxes. Contact this office for state reporting requirements.
- W-2 and W-3 Forms: At the end of the year, you must provide your household employee with a Form W-2, Wage and Tax Statement, and file a copy with the Social Security Administration along with Form W-3, Transmittal of Wage and Tax Statements. These forms are generally due by January 31 following the year you paid the employee.
"Nanny" SEPs
A recent tax law change allows employers of domestic employees to establish a Simplified Employee Pension (SEP) plan to provide retirement benefits for their domestic employees, such as nannies. These plans have come to be termed "Nanny" SEPs, but can be made available to other types of domestic employees.
- Tax Treatment: Contributions made to a SEP are generally tax-deferred for the employee, meaning the employee does not pay taxes on the contributions until they withdraw the funds, typically during retirement.
- Distribution Rules: Distributions from SEPs are taxed similarly to IRA distributions. Early withdrawal penalties may apply if funds are withdrawn before the employee reaches age 59½.
- Required Minimum Distributions (RMDs): Employees must start taking required minimum distributions from the SEP once they reach the age of 73 (or 70½ if they reached that age before 2020, or if they attained age 72 during 2020 through 2022).
- No Loans: Loans are not permitted from SEP plans, as they are considered IRA-based plans.
This provision allows domestic employees to benefit from retirement savings plans like those available to employees in other sectors, promoting financial security for these workers. This is not a requirement but can be a valuable benefit to attract and retain quality household employees.
Deductibility of Household Employee Payments
Payments to household employees, and the employer's associated payroll tax payments, are generally considered personal expenses and are not deductible. However, there are exceptions:
- Medical Expenses: Wages and other amounts paid for nursing services can be included as medical expenses if the services are necessary for medical care. This includes services such as administering medication, bathing, and grooming the patient.
- Child and Dependent Care Credit: Expenses for household services or care of a qualifying individual that allow the taxpayer to work may qualify for the child and dependent care credit. However, the same expense cannot be used both as a medical expense and for the child and dependent care credit.
Penalties for Non-Compliance
Failing to comply with household employment tax requirements can result in significant penalties:
- Failure to Withhold and Pay Taxes: If you do not withhold and pay Social Security, Medicare, and FUTA taxes, you may be liable for the unpaid taxes, plus interest and penalties.
- Failure to File Forms: Not filing required forms, such as Form W-2, can result in penalties. For example, the penalty for failing to file a correct Form W-2 by the due date can range from $60 to $330 per form, depending on how late the form is filed.
- Misclassification of Employees: Misclassifying an employee as an independent contractor to avoid payroll taxes can lead to back taxes, interest, and penalties. The IRS has strict guidelines for determining worker classification, and misclassification can result in significant financial consequences. Some states have different guidelines, often more restrictive than the federal rules.
Other Tax Issues:
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Overtime compensation: Domestic servants are nonexempt workers under the Fair Labor Standards Act (FLSA) and are entitled to overtime compensation for any work beyond 40 hours per week. In most states, live-in employees are an exception to this regulation.
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Salary vs. Hourly Pay: Treating nonexempt workers like paid workers is against the law. Employees working in households must be paid on an hourly basis, with overtime pay being allocated appropriately.
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Separate Payrolls: Company owners are required to keep track of domestic employees' separate payrolls. Paying domestic workers requires the use of personal finances, not company funds. Payrolling domestic employees on behalf of a business is not permitted as a business deduction.
Hiring domestic assistance has obligations beyond merely providing compensation. It is essential to comprehend worker categorization, follow withholding and payroll regulations, and fulfill tax reporting requirements in order to stay out of trouble and maintain legal compliance. Furthermore, providing benefits like Nanny SEPs might aid in luring and keeping in-home care.
For assistance in fulfilling state and federal reporting responsibilities, please get in touch with our office.
