As tax season fast approaches, it’s in your best interest to understand exactly which taxes you are required to pay if you employ household workers. In short, household employers are obligated to file state and federal taxes on behalf of their employee or risk the stiff penalties that come along with filing falsely- even if unintentionally. Typically, the family employer is unaware of the differences between reporting wages for an independent contractor and reporting them for a household employee.
The differences between an independent contractor and a household employee are clearly explained by the U.S. Small Business Administration and knowing this distinction will help you determine how you withhold a variety of taxes and avoid costly legal consequences.
“A household employee is a domestic worker such as a housekeeper, nanny, home health aide, maid or elder companion,” advises Guy Maddalone, founder of GTM Associates. “They work in your home and execute daily tasks how you, the employer, would like them done. As their employer, you also establish their schedule and provide the supplies and materials needed to do the job.”
An independent contractor offers services to the public, provides their own equipment to complete the job and dictates their own hours. They are self employed workers who can subcontract other employees and pay for any outside resources that are needed. Independent contractors keep their own business records and operate under a business name.
In a personal finance article on cnbc.com, Kathleen Webb, president and co-founder of HomeWork Solutions, a household payroll consultancy in Sterling, Va. reminds the reader of the risks in mis-reporting employment and payroll taxes: home care employer obligations are folded into your personal income taxes. She notes that since a family signs personal income tax filing under penalty of perjury, the risks to personal finances are real. Webb estimates that the nanny tax noncompliance rate is in the 80 to 90 percent range.
This comes down to a key question: “Do I issue my employee a W-2 or a 1099?”
A W-2 is required for any household employees who receive payments of $1900 in the calendar year (2014), or any household employee who had income taxes deducted from their payroll. An employer is responsible for paying half of Medicare and Social Security taxes for each employee. The remaining half is the obligation of the employee, however if the employer does not collect the employee portion the employer will have to make the payments to the IRS. The employer is also responsible for paying the federal unemployment tax and to remit federal income tax withholding they deducted from employee paychecks. The percentage that is deducted for income taxes varies based on the employee’s income and personal situation.
If you’re employed as a nanny, it might sound like a better option to be classified as an independent contractor- who wouldn’t want to see more money in their paycheck at the end of each pay period? However, self-employed individuals are taxed differently and in the end, the nannies improperly called “independent contractors” are actually paying more in taxes. The other benefit of employee status is the protection you secure under labor laws related to overtime, disability, and nondiscrimination laws. At the end of the day this is not a choice – the IRS definitively classifies nannies and most individual household workers as employees.
In contrast, a 1099 is provided to an independent contractors who is liable for paying her own taxes. Pay is submitted in full, without any taxes withheld. “To be designated as an independent contractor, a worker must be able to set her own hours, prices and work location, can work for multiple employers, and uses her own equipment to perform her tasks,” Tom Breedlove of Care.com HomePay explains. “Think of a gardening or housecleaning service as good examples.” The independent contractor is solely responsible for filing and paying income taxes, along with the self-employment tax.
In addition to federal tax regulations, which dictate that an employer paying a household worker $1,800 per year must file employment taxes, there are also the various state taxes to consider. For example, an employer in California must register their employee if they earn $750 per calendar quarter. In New York, the law requires a declaration of employment if an employee earns $500 per calendar quarter. In Texas, domestic employers must pay state unemployment taxes if an employee earns $1,000 per calendar quarter. Workers’ compensation insurance laws also vary from state to state. It is the responsibility of the employer to register with the state when a household employee is hired.
Determining the tax differences between household employees and independent contractors will prevent penalties including fines and staggering legal fees. There are several well respected household payroll and tax services who are INA Supporting Members. You may locate INA Member Payroll and Tax Services in the INA’s Digital Member Directory.
Reinforcing your nanny agency with the correct nanny payroll and tax guidance is imperative for success. Download our free INA Agency Marketing Toolkit for more inspiration.
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INA Annual Conference Reminder
Hundreds of nannies, nanny agency owners and their staff, nanny educators and representatives of supporting industry services such as nanny payroll and nanny tax compliance firms, pre-employment screening services, and nanny educators will meet in Los Angeles, CA March 27 – 30 2014 for three days of educational workshops and peer networking. Special EARLY BIRD pricing expires February 22, 2014 – don’t delay, enroll today!