I Want A Nanny, Not An Employee!!
Aug 5, 2014
I was talking to a client several months ago and the topic came up--as these things usually do--about some friends who had a nanny. "Nanna" apparently had just come back from her tax preparer's office and she was not liking the news she had received.
You see, "Nanna" had previously been employed by a daycare center, she got taxes deducted from her paycheck every week, received her W-2 at the end of each year, and had received refunds since she first began working at the daycare. It was pretty much a "rinse-and-repeat" tax situation each year.
Not so this year. "Nanna" was so good at her job that she had been recruited by our client's friends to work for them and watch their children exclusively--without having other kids competing for her nurturing attention.
The change occurred mid-year and everything went relatively well. "Nanna" agreed to receive a certain amount per hour, and in exchange, she would watch the kids in their own home. Because "Nanna" was doing the job on her own accord, could bring the kids wherever (within reason, of course), drove herself to their home, etc, they treated her as self-employed and did not take any taxes out of her pay. She was receiving more money each week than she ever had and the parents were getting a nanny who was great with the kids. Everyone was happy.
Then tax season came around. When "Nanna" went to file her taxes, they asked her about the decrease in her W-2 and what else had she been up to during the year? She told them that she was working as a nanny and that she got about $400 every week and she was self-employed. She had kept all her pay stubs and she had some mileage and a few scant expenses--nothing much, really. The bottom line was that she was owing taxes this year, mainly because of the Self Employment (SE) tax.
"Welcome to the real world, Sweetheart!" I can almost hear all our self-employed people out there saying. However, in a twist provided by our tax code, there is a quirky rule applying to nannies and other domestic workers (maids, gardeners, drivers, butlers, etc) who work in your household.
You see, whether they work one day a week (ex: maid comes in every Wednesday) or they live with you 24/7 (ex: a live-in nanny or caretaker), many household and other domestic workers are considered to be employees of the homeowner.
Here's the lowdown, straight from IRS site:
"You have a household employee if you hired someone to do household work and that worker is your employee. The worker is your employee if you can control not only what work is done, but how it is done. If the worker is your employee, it does not matter whether the work is full time or part time or that you hired the worker through an agency or from a list provided by an agency or association. It also does not matter whether you pay the worker on an hourly, daily, or weekly basis, or by the job."
Therefore, these employees are not considered self-employed and they should not receive a form 1099 at the end of the year. They should receive a form W-2, just like any other employee.
"Oh great, so now I have to withhold taxes and report forms to IRS every quarter?!?" you may wonder. The answer is no. While you will need to get an Employer ID Number (see link below), IRS has said that while they are employees and are indeed subject to the same FICA, federal, and state taxes, the homeowner does not have to report these taxes on a quarterly basis. Homeowners instead are required to file a 1040 "Schedule H" at the end of the year with their own personal tax return and pay the taxes at that time.
In their own website example, IRS suggests that the homeowner can choose to pay the entire FICA liability and not deduct anything from the employee's wages! In those cases, the employees get the best of both worlds--they get a full check like a self-employed person does, but are not responsible for paying the self-employment tax since the homeowner is paying it on their behalf.
The sad thing is that if employers/employees are not clear on this, domestic employees may still be in for a shock because homeowners are only required to withhold (or pay) FICA taxes at the end of the year, not federal or state income taxes. This means that, in most cases, domestic employees will not have any income tax withheld and may still end up owing tax at the end of the year. In those cases, we recommend that the employee pays estimated taxes every quarter using estimated voucher coupons (for both federal and state).
So what happened to "Nanna"? Fortunately for her, she was filing in January and the homeowners had not yet issued a 1099 in her name. After I spoke to our client, she relayed the information and the homeowners issued a form W-2 and eventually reported/paid the taxes using Schedule H when they filed their own taxes. They're so happy with her services, that they paid the entire amount out of their own pocket, without making "Nanna" repay the portion of the FICA tax that should have been withheld from her pay each week.
They also explained to her that she should pay estimated taxes to cover her federal and state tax bill at the end of the year. In fact, they gave "Nanna" our phone number, and she called the other day asking how much to send in for her estimated amounts. The basic rule is to send 100% of the income tax you owed last year, or 90% of this year's tax liability. Since it's much easier to just take last year's figure and divide by four (estimated payments are due each quarter), that is the approach she took.
If you're interested, though, the "90%" method would require her to look at her YTD earnings every quarter, extrapolate and annualize the figures, calculate the tax due by basically preparing the entire income tax return; multiply the calculated tax due by 90%, divide by four; multiply by the number of quarters that have passed so far, subtract the estimated payments that have already been paid in previous quarters, and then send the difference to IRS. Then repeat for the state calculation. This method is overkill for someone who practically gets paid the same amount every week, so it's usually reserved for self-employed individuals and companies whose income fluctuates from year to year.
Now here's a twist that would shock even M. Night Shyamalan (yeah, I googled the spelling): if "Nanna" would have been incorporated, been an LLC, work for a babysitting agency, or watched the kids at her place, then she would be considered self-employed and this entire article that worked so hard to lead you into thinking one way would not apply.
So to generalize...if the individual has an LLC, corporation, provides the service in their own home, or is employed by an agency--that person is not your employee. Otherwise, you better get a water cooler, handbooks, and your "World's Greatest Boss" coffee mug because you've got yourself an employee!
Check out the links below for more details:
APPLY FOR EIN:
RULES AND EXAMPLES OF HOUSEHOLD EMPLOYEES: