If you’re fortunate, your clients will tell you they hired a childcare worker for their family before they start and not in the middle of tax season when you’ll need to play catch up during the busiest time of your year.
Your clients may want to pay on the books, but are unsure how to get started as this is their first household employee. Here are eight questions to ask to make sure you and your client understand their tax and payroll obligations when hiring a nanny and what it takes to be compliant with tax, wage, and labor laws.
1. Did you get a Federal Employer Identification Number (EIN)?
Most likely they haven’t, but they’ll need one in order to pay their employee and remit taxes including federal unemployment taxes. This unique, nine-digit number is assigned by the IRS and can be obtained online.
2. Did you notify the state that you have hired an employee?
There will be paperwork to complete with the state’s labor department as well, which may include filing a new hire report, obtaining a withholding identification number and setting up a state unemployment insurance account. Your client will likely need their federal EIN before registering as an employer with their state.
3. Do you understand that you’ve hired an employee and not an independent contractor?
It may be tempting for a family to classify their employee as an independent contractor and not have to worry about withholding and paying taxes or workers’ compensation insurance. But misclassification is considered federal tax evasion and is a costly mistake with fines and penalties running into the thousands of dollars not to mention paying back taxes above and beyond what they should have paid in the first place. Classification comes down to an issue of control.
With a household employee like a nanny, the family tells their worker how to care for their child and when to come to work and supplies tools and equipment for their worker to do their job. Because the family is in control of employment, they have an employee.
An independent contractor, on the other hand, will decide how the work will be done, determine when they will work, and use their own supplies to complete the work. The worker, in this case, is in control and assumes both employer and employee tax responsibilities.
In just about every case, the IRS says a household worker is an employee. Your client could file Form SS-8 to get a determination on worker status from the IRS.
4. Did you check minimum wage rates and overtime regulations?
Nannies and other household employees are covered by the Fair Labor Standards Act, which means they need to be paid no less than minimum wage and receive an overtime rate of at least time-and-a-half for hours worked over 40 in a week. Some states may have different overtime rules for live-in employees and senior care workers could be exempt from overtime pay if they’re providing companionship care.
While the federal minimum wage rate is $7.25/hour, many states and localities have much higher rates. Your client needs to pay at least the highest applicable minimum wage rate. Also, nannies are hourly employees and shouldn’t be paid a salary.
5. Did you look up any domestic workers’ bill of rights, paid family leave or paid sick leave laws for your state?
Several states – including California, Illinois, Massachusetts, and New York among others – and some cities like Seattle have passed “bills of rights” that cover nannies and other household workers. These regulations may dictate the information that needs to appear on an employee’s pay check, how often they are to be paid, number of consecutive days they can work, when overtime kicks in, required paid time off, and more. Recent state-level paid family leave and paid sick leave laws may also apply to household employers even if they have just one worker.
6. Did you give your employee Form I-9?
Just like employees in traditional workplaces complete Form I-9 before or within days after they start work, nannies must do the same for their families. The form is required for citizens and non-citizens. It verifies an employee’s identity and authorization to work in the United States and should be kept on file for three years after the date of hire or one year after the employment is terminated, whichever is later. Form I-9 doesn’t need to be filed with any federal agency.
7. Do you understand your total tax obligation?
If your client pays their employee $2,100 or more in the calendar year, they will need to withhold and pay Social Security and Medicare taxes (commonly called FICA taxes). The family pays 7.65 percent of cash wages and withholds the same amount from their employee’s pay. Your client can choose to pay their employee’s share for a total commitment of 15.3 percent.
If your client’s employee receives $1,000 or more in cash wages in any calendar quarter, then your client needs to pay federal unemployment taxes of six percent on the first $7,000 in wages. They may owe state unemployment tax as well.
For FICA, your client doesn’t need to count wages paid to their spouse, their child under age 21, their parent, or any employee under age 18. For FUTA, they don’t need to pay taxes on their spouse, their child under age 21 or their parent.
Using a nanny tax calculator can help you and your client better understand their total financial obligation, which would be their nanny’s pay plus employer taxes less any tax savings through a Flexible Spending Account and/or the child and dependent care credit on their personal tax return.
Withholding income taxes from their employee’s pay is optional. However, it’s a good idea so that their nanny is not stuck paying their entire tax responsibility come tax time.
8. Do you need workers’ compensation insurance?
Household employers in many states are required to carry workers’ compensation insurance, which can help pay an employee and cover some medical expenses if they are hurt or get sick while on the job.
Not having coverage is one of the biggest financial risks your client can make as a household employer. Fines and penalties can easily run into the tens of thousands of dollars and your client is exposed to legal action by their employee to recover medical costs and lost wages.
In California and New Jersey, workers’ compensation can be added to a home owner’s policy.
Even in states where coverage is voluntary, it may be a good idea for your client to get a policy, which may cost a just few hundred dollars a year, just for the peace of mind that their employee gets some financial assistance if they get injured at work.
By asking these questions and doing this work up front, your client will minimize the risks of non-compliance with tax, wage, and labor laws and you’ll eliminate a lot of the hassles of catching up on nanny taxes come tax season.
About Guy Maddalone
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 is also the author of How to Hire a Nanny and How to Hire a Caregiver for Your Senior.