Mistake #1: Misclassifying the worker as an independent contractor.
If you hire someone to work in your home, the IRS considers that person to be your employee. Classifying the worker as an independent contractor (by using Form 1099) is considered tax evasion. Beware: the IRS recently announced a major enforcement initiative targeting several key industries, including household employment.
Mistake #2: Failure to properly address overtime.
Nannies and other household employees are considered non-exempt workers under the Fair Labor Standards Act. That means their employer is required to pay overtime for all hours over 40 in a 7-day work week (live-in nannies are generally an exception to this rule, although a few states require live-ins to be paid overtime as well). Overtime hours must be paid at a rate that is at least 1.5 times the regular rate of pay.
Many families try to side-step overtime by offering a salary. In their minds, jobs that pay a salary — instead of hourly — are legally able to pay a fixed amount of wages regardless of how many hours the employee works. This is true in most “white-collar,” “highly-compensated” professions because workers in these types of jobs are not prone to abuse. In the case of household workers, however, employers must make sure to properly address overtime pay.
Note about overtime: If the worker and employer agree to a salary based on a schedule that regularly includes more than 40 hours, the family should protect themselves by addressing overtime in an employment agreement that is signed by the employee. For example: Family and nanny agree to $450 per week based on a 45-hour work week. The employment agreement should specify that the weekly compensation was calculated based 40 hours at the regular rate of pay $9.47/hr plus 5 hours at the overtime rate of $14.21/hr. Additionally, it must be stated that any hours over 45 in a work week will be paid at the overtime rate of $14.21.
Overtime issues are particularly dangerous for employers because there is no statute of limitations. So former employees can file a wage dispute many years after the relationship has terminated. Back wages plus back taxes, penalties and interest can make this a very expensive mistake. The good news is a simple employment agreement makes all the worries go away.
Mistake #3: Putting a household employee on the company payroll.
Household employees are not considered direct contributors to the success of a business. And since businesses are entitled to tax deductions on payroll expense, it is an illegal tax deduction to include a domestic worker’s payroll expense as part of the company payroll and tax reporting. Instead, it should be handled separately through the household employment reporting process. If the expense is childcare related, the family can take the tax breaks associated with those wages — but it must be handled on the personal income tax return.
Based on this same logic, it is considered insurance fraud to put a household employee on the company’s group health plan.
Mistake #4: Failing to properly withhold and report payroll taxes.
Household employers are required to administer the payroll tax withholding and reporting process:
1. Establish household employer tax IDs with the proper state and federal tax authorities;
2. File a New Hire Report with your state (usually within 14 days of the employee’s start date although some states mandate the report be done within 7 days);
3. Calculate the proper tax withholdings each pay period and keep track of the totals (Social Security is 6.2%; Medicare is 1.45%; federal and state income taxes are based on the employee’s Form W-4 selections; other employee taxes vary by state)
4. File quarterly tax returns with the state and remit the employee’s state taxes along with your employer state taxes (i.e. unemployment)
5. File 1040-ES returns with the IRS and remit the employee’s federal taxes along with your employer federal taxes (i.e. Social Security & Medicare match)
6. At the end of each tax year:
6a. Prepare Form W-2 for any and all employees who had wages during the year.
6b. File Form W-2 Copy A and Form W-3 with the Social Security Administration.
6c. Prepare Schedule H and include it with your personal federal income tax return.
7. Monitor ever-changing tax and labor law and respond to notices, alerts and inquiries from the state and federal tax agencies.
Mistake #5: Failure to secure workers’ compensation insurance.
Workers’ compensation insurance provides financial assistance with lost wages and medical costs in the event that your employee becomes injured or ill as a result of the workplace or job duty. It is not required for household employers in all states (check your state or our website for a listing of requirement thresholds by state). If you are required to carry a workers’ compensation policy — or if you elect to carry one — check with your homeowner’s insurance provider first. Many umbrella policies already include coverage for domestic workers.
Note about workers’ compensation: A few states (i.e. New York, New Hampshire, and Ohio) require that policies be obtained through the state.
BONUS: When you successfully navigate these potentially-expensive problem areas, you are entitled to one or more significant tax breaks and your employee receives many critical benefits and protections.