A household employee is someone that you pay to perform duties in or around your home. A household employee is considered an employee for tax and liability purposes if you control when, where, how or by whom the work should be performed. This list of people commonly includes nannies, medical caregivers, housekeepers, chefs, personal assistants, household managers and so on. Misclassifying these employees as independent contractors – or even worse – paying them with cash “off the books” may constitute tax evasion and cost you dearly in the event of an accident.
For tax purposes, you would be required to get a household employer Tax ID number, file a new hire report, prepare and distribute pay stubs, file quarterly employment tax returns with the federal and state taxing authorities and distribute a W-2 and monitor the ever-changing tax and labor laws. For example, both overtime and paid time off provisions could come into play in your state and there is no statute of limitations with respect to overtime pay. Your household employee can complain to your local department of labor any time they want to make your life difficult.
I’m not trying to be your kill joy and create more work for your accountants or home payroll provider, I’m just trying to keep you out of trouble. It doesn’t matter that you think your household employee is happy to receive undocumented cash payments from you. All your employee needs to do is to file a complaint with the taxing authorities and you will be found guilty as long as the person is in fact a household employee. You will owe back taxes, along with penalties and interest on the amounts that you should have reported and withheld, including Social Security taxes.
If you own a business, it’s tempting to simply put this household employee on your company’s payroll. Under audit, however, that deduction would be disallowed as that employee does not work directly for your company.
You would also be required to carry worker’s compensation insurance for this household employee in most states, however, it’s important coverage to have regardless of where you may live. Whether you properly report the payroll or not, an accident on the job could cost you everything without the proper coverage. For those that own their own business, your company’s workers’ compensation policy does not apply to your household employee. Any claims may be denied as they investigate the cause and location of the claim. This also leaves you personally vulnerable to settle any claim that’s legitimately brought against you.
A small benefit of doing this right is that it may make you eligible for the child or dependent care tax credit (IRS Form 2441) as well as the ability to use your flexible spending account from work to pay for a portion of the costs on a pre-tax basis. The big benefits from doing it right is protecting your assets and staying on the right side of the tax laws.
John P. Napolitano CFP®, CPA, PFS, MST is Founder and Chairman of Napier Financial in Braintree, MA. Visit napierfinancial.com for more information. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Legal counsel should be consulted for specific advice or recommendations about any individual’s personal legal circumstances. Investment and financial planning advice offered through US Financial Advisors and Great Valley Advisor Group, Registered Investment Advisors.
