Many households employ childcare providers, housekeepers, gardeners, and other types of domestic help. Relatively few taxpayers, however, are familiar with the tax issues around paying them. It’s easy to assume that people you employee for household help qualify as independent contractors and that you just need to pay them a wage and let them take care of their own taxes.
Unfortunately, it’s a little more complicated than that.
Some workers, under some circumstances, are independent contractors for tax purposes. Others are considered household employees, meaning that as their employer, you are responsible for reporting wages and paying certain taxes.
And that brings us to the nanny tax.
What is the Nanny Tax?
The nanny tax is a federal tax paid by people who employ household employees and pay wages of $2600 or more per year, or $1000 or more per quarter.
Despite the name, it applies to all household employees, not just nannies.
Why You Should be Concerned
It’s fairly common practice to pay household help “under the table,” meaning that the employer doesn’t withhold wages or report that income to the IRS. That’s fine if you’re paying your 15-year-old neighbor to babysit your kids for a couple of hours a month, but it’s a risky proposition when dealing with other types of help.
Penalties for failing to comply with household employee tax regulations range from tax penalties and fines to criminal charges that could lead to felony convictions. And if you’re paying people under the table, it’s only going to get harder to get away with it in 2023.
For one thing, worker classification is getting stricter, and the government is cracking down on employers who misclassify employees.
For another, beginning this year, payments of more than $600 made through Venmo, CashApp, or other third-party platforms will trigger 1099-Ks, creating a tax obligation for workers paid via those platforms.
Finally, in case you hadn’t noticed, the general economic climate right now is “uncertain.” Inflation is pushing wages higher, meaning that we’ll probably see more household workers crossing the threshold for tax reporting. At the same time, companies around the country are laying off workers. That will probably lead to more families laying off their own employees, who may trigger the interest of the IRS if they apply for unemployment benefits without a tax history.
Household Employee vs. Independent Contractor
Just because someone works in your home doesn’t mean they’re necessarily an employee.
The difference between a household employee and an independent contractor is determined by the degree of control and independence the household employer has over the worker. The general rule is that if the household employer has the right to control and direct the work of the employee, including what work is done and how it is done, the worker is considered an employee.
On the other hand, if the worker is free to perform the work as they see fit, with limited direction or control from the household employer, they are considered an independent contractor.
For example, a nanny who provides full-time, in-home care to your children is most likely a household employee, as you are controlling when, how, and where the work is performed.
On the other hand, a housekeeper who has her own home-cleaning business, serves multiple customers, brings her own supplies, and hires and pays any workers she needs would be considered an independent contractor.
Types of Household Employees
In order to be considered a household employee, workers must perform services in or around your private home. However, services “not of a household nature,” such as tutor or private secretary, are not considered household work.
Examples of people the IRS might consider household workers include:
- Cleaning people
- Domestic workers
- Health aides
- Private nurses
- Yard workers
However, the following people are not considered household employees, regardless of whether or how much you pay them:
- Your spouse
- Your child who is under age 21
- Your parent (unless an exception is met)
- An employee who is under age 18 at any time during the year, unless performing household work is the employee’s principal occupation.
Assuming a worker qualifies as a household worker, not an independent contractor, what are the employer’s obligations?
The first step is to file to become an employer and receive an employer identification number (EIN) from the IRS. The next is to verify that your employee is legally eligible to work in the United States.
If an employee earns cash wages of $2,600 or more in 2023, the employer should withhold 15.3% of the total amount for social security and Medicare taxes. The employer and employee should each contribute half (7.65% apiece). If the employee earns $1,000 or more in cash wages per quarter, the employer is responsible for paying a 6% federal unemployment tax on annual cash wages up to $7,000.
Employers should report the income and taxes of their household employees by providing their employee with a Form W-2, filing a Form W-3 and Form W-2 Copy A with the Social Security Administration (SSA), and submitting a Schedule H reporting the employee’s wages and taxes with their federal tax return.
Don’t forget about state taxes: in addition to federal taxes, you may also be required to pay state and local taxes for your employees, including state unemployment tax and state disability insurance.
If you employ an au pair (a young person from abroad in the US on a J-1 visa), you are subject to a different set of withholding and reporting rules.
The Silver Lining
Employers who have registered their employees appropriately with the IRS are eligible to obtain workers’ compensation insurance, protecting them in the event of an accident in the home that involves an employee.
If I Didn’t Pay the Nanny Tax in 2022, Is It too Late?
Not necessarily. If you didn’t withhold or report taxes for your domestic help last year, you can, in most cases, sort it out retroactively, but you must do it before you file your 2022 taxes.
If you’re concerned about your tax obligations to your domestic help, aren’t sure if you are withholding taxes appropriately, or want to be sure you’re taking advantage of available FSAs and credits, we encourage you to contact the CPAs at Tonneson. We’re here to help.
Contact us at Tonneson + Co today to learn how we can help.
If you’re interested in working with Tonneson + Co, please reach out to us. We look forward to hearing from you!