7 Steps to Help Clients Follow Nanny Tax Laws
If your client has or is hiring an employee, like a nanny or housekeeper, to work in their home, there are a few actions they should take to stay out of trouble with federal and state agencies.
Here are some practical steps to make your (and your client’s) life easier come tax time. Most of these can be taken before their employee even starts work.
1. Use the “Employee” Classification
The IRS has consistently ruled that a household worker is an employee and not an independent contractor. It’s really quite simple. The family provides instructions, sets the worker’s schedule and provides the tools and equipment to do the job. If there is any doubt, the family can file Form SS-8 with the IRS for a determination of the worker’s status.
Misclassifying a household employee as an independent contractor is considered felony tax evasion. Domestic workers should receive a W-2 at the end of the year, not a 1099.
2. Pay at Least Minimum Wage and Overtime
By federal law, a household employee is required to be paid at least the federal minimum wage, which is currently $7.25/hour. Many states and cities have higher rates, and your client must pay at least the highest of the federal, state or local rate. Also, domestic workers need to be paid time and a half for any hours they work in addition to the usual 40. Depending on the state, there may be exceptions for live-in employees and those who provide companionship care.
This is often where clients run into legal trouble; they can even make tabloid headlines if they’re a high-profile family. They fail to pay minimum wage and/or overtime, and the employee becomes disgruntled, quits and sues for back wages. Lawsuits can be costly, not to mention the time and effort needed go through payroll records (if there even are any).
3. Track Their Employee’s Hours
How often a household employee gets paid and what should appear on their paycheck is often dictated by state law or a Domestic Workers’ Bill of Rights. If your client is not paying taxes quarterly, tracking hours worked will help you put together their annual tax return. The last thing you want, especially during the height of tax season, is for a client to tell you they have a nanny, pay her in cash and haven’t been keeping track of her hours. You’ll need to piece that together to determine your client’s nanny tax obligation and provide a W-2 to the nanny.
4. Use Form I-9 to Determine Work Eligibility
Before an employee begins work (or within a few days of the start of employment), they should provide your client with Form I-9 and documents that support their identity and employment authorization. Employer audits performed by the U.S. Immigration and Customs Enforcement (ICE) have skyrocketed this fiscal year. While most of these investigations have focused on businesses, ICE says it wants to eliminate the magnet of U.S. jobs for illegal immigrants.
5. Get Worker’s Compensation Insurance
This is the easiest step to miss and often the costliest. Your client may not even realize worker’s comp is required in their state for families with a household employee. Coverage requirement varies by state and is often based on hours worked or wages earned. Some states, like California and New Jersey, allow you to add worker’s comp to a homeowner’s insurance policy.
Skipping coverage altogether is a big mistake. In New York, for example, the penalty is $2,000 for every 10 days without coverage.
6. Keep Household and Business Payrolls Separate
Another popular and seemingly easy way to avoid “nanny taxes” is to add a household employee to the company payroll. In most cases, this is illegal, as domestic workers do not directly impact the success of a business the way a company employee does. Including one on your client’s business payroll is considered an illegal tax deduction.
Household employment taxes must be reported with your client’s personal tax return and paid quarterly or annually.
7. Use Schedule H, Not Form 941
Household employment taxes should be reported on Schedule H, which is filed with your client’s personal tax return. Using Form 941 instead can create more work for your client, increase the risk of penalties and result in dual reporting to the IRS. Sometimes, a business payroll firm trying to do household payroll will use Form 941 because that’s what they use with their commercial clients. You may even do the same if you’re unfamiliar with nanny taxes.
Here’s the difference: Schedule H is filed once, whereas Form 941 needs to be filed every quarter, even if your client didn’t pay an employee during that period. Fail to file Form 941 because you had no payroll, and watch the penalties stack up.
Here’s another scenario that I’ve seen happen. The family is paying their nanny taxes, on their own or through a business payroll company, using Form 941. At the end of the year, you ask them about household employment, and they acknowledge they had a domestic worker. You gather the relevant pay information, figure out the taxes owed and file Schedule H. Now your client has reported and paid their nanny taxes twice, once on Form 941 and then on their personal return, which will either increase what they owe or reduce their refund.
There are a couple of exceptions when Form 941 may make sense for reporting nanny taxes. If your client is a sole proprietor or the home is on a farm operated for profit, they can report household employment taxes on their company’s Form 941. This does not mean they can add the domestic employee to their business payroll. It would solely be used to report taxes.
However, to keep things simple, you may want to keep household and business payrolls separate.
Employing a household worker creates plenty of administrative tasks for your client (and possibly you). But handling these tasks early on and following the proper steps to manage a domestic employee means less hassles at tax season and a reduced risk of fines and penalties.
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Guy Maddalone has more than 30 years of experience in the payroll, human resource, and employment services industries. In 1991, he founded GTM Payroll Services to provide payroll, tax, compliance, and insurance administration for families that hired a nanny or other household employees. Guy...