The 5 Things You Need to Know about Taxes and Domestic Employeesby
If you’re like most tax preparers, you haven’t had many clients with household employment situations—but this year may be different. Domestic Worker Bill of Rights legislation in several states has heightened awareness of the benefits of legal pay among household employees across the country. In addition, many domestic workers will qualify for the Affordable Care Act’s health insurance subsidy, but in order to do so they must have documented wages. For these reasons, you’ll likely have more household employment questions this year than ever before.
To navigate your clients safely through these potentially turbulent waters, here’s a quick refresher on the most common household employment issues:
The caregiver is an employee and the family is her employer. With few exceptions, the IRS says someone working in a family’s home constitutes an employer-employee arrangement. The reason is that the family generally controls the working relationship. They set the employee’s hours, determine what kind of work is performed and how the person is expected to do it. A common error in the household employment industry is for families to misclassify an employee as an independent contractor by providing Form 1099 at tax time. This is considered tax evasion and is on the enforcement radar of the IRS as well as the state and federal Departments of Labor.
Taxes must be withheld from the employee or else they become the employer’s responsibility. All household employees earning $1,900 or more during the calendar year must have Social Security and Medicare (FICA) taxes withheld from their pay—or else those taxes become the liability of the employer. While federal and state income taxes are not required to be withheld, it’s highly recommend so the employee isn’t subject to underpayment penalties.
Household employers are required to file state employment tax returns, typically on a quarterly basis, but monthly or annually in some states. (Read more about the filing requirements in your state.) Federal employment taxes can be remitted throughout the year via 1040-ES payments or with the client’s 1040 at the end of the year, along with Schedule H.
Families must keep track of overtime. Household employees are non-exempt workers according to the Fair Labor Standards Act (FLSA). As such, fixed salaries are illegal. The worker must be paid for every hour worked and overtime for all hours over 40 worked in a 7-day workweek. The only exception—in most states—is for live-in employees, who only need to be paid their regular hourly rate for every hour worked. It’s important for your clients to keep track of their employee’s hours and document the regular and overtime pay each pay period. The Domestic Worker Bill of Rights movement over the past couple of years has resulted in heightened worker awareness of overtime and other wage-and-hour law protections. Families that fail to comply expose themselves to potential wage disputes.
Workers’ Compensation Insurance. Workers’ compensation is not part of the tax and payroll process; it’s an insurance policy that provides financial assistance with lost wages and medical expenses in the event of work-related injury or illness. Some states require household employers to have workers’ comp coverage. However, even when it’s optional, it’s important for your clients to know that employers without coverage may be held liable for the amount of benefits that would have been awarded in a workers’ comp claim.
For that reason, we advise families to obtain a workers’ comp policy at the time of hire. It also has the added benefit of protecting the family from lawsuits since employees who accept benefits must forfeit their right to sue the family.
Tax Breaks. Families paying their caregiver legally are generally entitled to at least one of the two dependent care tax breaks, which can offset a large portion of their employer tax liability. There are no income restrictions on these tax breaks, but to qualify, the dependent must pass the Qualifying Persons test and both spouses must pass the work-related test. If those conditions are met, qualifying expenses—that is, wages paid to a caregiver—would count toward one or both of the following tax breaks:
- Dependent Care Account. Also known as a Flexible Spending Account (FSA), it allows families to pay for up to $5,000 of qualifying expenses using pre-tax dollars. Depending on their marginal tax rate, this will save around $2,000. Families enroll through their employers during the open enrollment period or within 30 days of a life-changing event.
- Child or Dependent Care Tax Credit (IRS Form 2441). Families may itemize dependent care expenses of up to $3,000 per child (maximum of $6,000). For most families, the tax credit percentage will be 20 percent, so this tax break saves $600 for families with one child and $1,200 for two or more children.
Note that families with two or more children can use both tax breaks by setting aside $5,000 in an FSA and applying the excess $1,000 in expenses on Form 2441.
The good news is these tax breaks help defray much of the additional costs of paying legally, and we find most families are pleasantly surprised at how affordable it is to handle things above board. And some families—especially those with lower wages (for example, NannyShares or part-time care)—will actually come out ahead by paying legally, meaning their tax savings will outweigh their employer tax costs. We have a free Household Employer Budgeting Calculator to help families understand the net effect of their employer taxes and dependent care tax breaks.
Most families want to handle their household employer obligations correctly, but have neither the aptitude, the appetite, nor the time to handle the details. For that reason, we see a lot of well-intended mistakes that could have easily been avoided with some professional guidance. This tax season, you may encounter some of these issues. As financial stewards, your clients will appreciate you steering them through this complex topic—protecting them from audits and wage disputes while saving them money on tax breaks.
About the author:
Tom Breedlove is Business Development Director of Care.com HomePay, a household employment specialist.He is co-author of "The Household Employer’s Financial, Taxes & HR Guide."