Five Things You Should Know Regarding Domestic Employees and Taxes
A domestic employee is one who is employed to work inside the household. This includes workers such as babysitters, caretakers, drivers, gardeners and lawn workers, health aides, housekeepers and maids, nannies, and private nurses.
Domestic Worker Bill of Rights legislation has been passed in many states; therefore, people who employ such workers will be taking steps to learn more about the guidelines this year. As a tax preparer, you’ll want to be aware of the questions that may arise. The following are five things you should know regarding domestic employees and taxes:
1. Employee vs. Independent Contractor
There is a major difference between someone hired as an employee and someone hired as a contractor. Generally, contractors control how the work is performed, provide their own supplies or tools, and offer services to the public. Employees have no control over how the work is performed. The employer sets the hours to be worked, provides guidelines for how to perform the job, and provides the supplies necessary.
Contractors receive Form 1099 while employees receive Form W-2. Household employers must ensure that the person is eligible to work in the United States. Employees must complete the U.S. Citizenship and Immigration Services Form I-9, Employment Eligibility Verification. The employer completes part of the form after verifying acceptable documents which prove a person’s eligibility to work in the United States.
2. Overtime Pay
According to the Fair Labor Standards Act, domestic employees are non-exempt workers. This means that they cannot be paid a fixed salary but must instead be paid hourly. Employers must pay overtime for hours worked over 40 hours a week; however, there are exceptions for live-in employees.
3. Tax Withholding
Household employers must withhold taxes from the employee or take responsibility for paying them. Employers must withhold Social Security and Medicare taxes if they pay $1,900 or more in cash wages during the year. Cash wages include wages paid by check, direct deposit or money order. Non-cash items such as food, lodging and transportation are not considered cash wages. The withholding amounts are 6.2% for Social Security tax and 1.45% for Medicare tax.
It’s not necessary to withhold federal or state income tax, but it is recommended to help the employee avoid underpayment penalties. Household employers may withhold federal or state income tax if the employee requests it. If the employer will withhold taxes, the employee must complete Form W-4, Employee’s Withholding Allowance Certificate.
4. Tax Breaks
Many families who hire domestic workers try to avoid tax issues by paying employees “under the table.” But paying wages legally can afford many tax breaks that may offset the costs of being an employer. In fact, in some cases, the tax breaks received may exceed the actual tax costs.
Families who employ domestic workers can use the dependent care tax credit to itemize expenses for dependent care of up to $3,000 per child, with a $6,000 maximum. The dependent must either be under age 13 or be disabled or incapacitated in some way.
Household employers qualify for this credit as long as the expenses were paid to allow them to work or look for work. Qualifying expenses can include the employer’s share of federal and state unemployment taxes, as well as employee wages.
A Dependent Care Account allows families to use pre-tax dollars to pay up to $5,000 for qualifying expenses. This means that the money household employers spend on dependent care is not taxed up front. A Dependent Care Account is also known as a Flexible Spending Account.
5. Workers’ Compensation and Unemployment Tax
Workers’ Compensation is an insurance policy that an employer takes out as protection in case an injury occurs on the job. The proceeds of the policy are used to pay for medical expenses or lost wages.
In some states, the insurance is optional; however, it is highly recommended. Without it, employers would be liable for any costs incurred by the employee. In addition, workers’ compensation protects employers against being sued, as employees who accept the benefits forfeit their right to sue for losses.
Federal unemployment tax provides compensation to employees who lose their jobs. Household employers may be required to pay federal unemployment tax, state unemployment tax, or both. The tax is typically 6% of the employee’s wages, but employers may be eligible for a credit of up to 5.4%. The unemployment tax is not withheld from the employee’s wages; it is paid out of the employer’s own funds.
Hiring a domestic employee is a big help to many families; however, many don’t know how to correctly handle the details to make sure they don’t get in trouble with the Internal Revenue Service. As a professional tax preparer, your guidance is needed. You can help families avoid costly mistakes and help them get the tax breaks that they are entitled to.
The bottom line is, tax credits are important for both you and your clients. As a tax preparer, you’ve got to impart this information to your clients effectively. During this tax season, you should consider streamlining your processes to be more of an advisor to clients, instead of doing the grunt work of tax filings.
One way to free up countless hours to advise clients is to efile 1099 and W-2 forms, instead of paper filing. One step further is to use a service that handles the delivery of the recipient tax forms for you. Probably the best known provider that allows you to file 1099 online, as well as doing the delivery of printed forms is eFile4Biz.com.
I’ve attached their video below, but I’ve saved over 260 hours every tax season for the past 3 years using their web software and service. Check them out. They may be a good fit for you.
Have ideas on this topic? Please visit our Instapaper page and post your comments or recommend other resources to discuss this concept.