A Primer on Household Employees: avoiding adverse tax implications.
As demonstrated, the "nanny tax" has been a recurring theme around appointees for public office; however, it also applies to the average citizen who hires household help. The most common tax problem related to household employees is the nonpayment of income, Social Security, and unemployment taxes. Because the compensation threshold is rather low for withholding purposes, many employers might be unaware that they need to withhold and remit various payroll taxes, operating under the mistaken belief that their household help makes too little money. Although this is one of the more obscure areas of taxation, as the hiring of household employees is not a common situation to the majority of taxpayers, it is helpful for tax advisors to develop an understanding of common tax issues related to household employees and domestic workers.
Types of Household Employees
A household employee is generally defined as someone hired by an individual taxpayer to do household work. Common household workers include babysitters, nannies, housekeepers, maids, private nurses, and gardeners. A worker is generally classified as an employee if the taxpayer controls not only the work that is done, but how the work is done. If a worker is not an employee, then the worker is self-employed and considered an independent contractor.
Workers classified as independent contractors pay their own Social Security and income taxes. Generally, self-employed individuals offer their services to the general public, provide their own tools, and determine their own work schedules. The IRS provides information regarding the classification of workers as either independent contractors or employees. Publication 15-A, Employer's Supplemental Tax Guide, discusses the differences between an independent contractor and an employee. A taxpayer can also complete Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, based on the information provided, the IRS will determine if the worker is an independent contractor or an employee (see also IRS Publication 1779, Independent Contractor or Employee).
Legality of household employees. An employer must determine the legality of the household employee to work in the United States. When a household worker is hired, both the employee and the employer must complete the U.S. Citizenship and Immigration Services (USCIS) Form 1-9, Employment Eligibility Verification, no later than the time of hire. The employer section requires the employer to review certain documents presented by the employee as evidence of the employee's identity and employment eligibility (acceptable documentation is listed on the form). The employee section of the form asks for certain required information and attests to the employee's current work eligibility status. The Form 1-9 is not sent to the USCIS, the IRS, or any other government agency, but is retained by the employer and made available for inspection if requested. (See USCIS Handbook for Employers [Form M-274] for additional information.) families. Medicare taxes pay for hospital insurance. The employer's sham of Social Security taxes is 6.2% of wages and 1.45% of applicable wages for Medicare taxes, and, for 2013, the employee's share is the same.
Along with the regular Medicare tax of 1.45%, the employer must withhold an additional Medicare tax of 0.9% on wages paid to an employee in excess of $200,000 for the calendar year. The additional Medicare tax withholding begins in the pay period in which the wages in excess of $200,000 are paid, and the withholding continues for each pay period until the end of the calendar year. This tax is imposed only on the employee, with no employer-matching amount.
The employer is responsible for payment of both the employer's and employee's Social Security and Medicare taxes. An employer has the option of withholding the employee's share of Social Security and Medicare taxes from the employee's wages or paying both from the employer's funds. If an employer pays the employee's share of Social Security and Medicare taxes, these taxes must be added to the employee's wages for income tax purposes. The additional taxes paid by the employer are not included for Social Security, Medicare, or federal unemployment wage purposes.
If a household worker earns cash wages for 2013 of $1,800 or more ($1,900 or more for 20141), these are considered Social Security and Medicare wages, regardless of when they were paid. If a worker earns less than $1,800 in cash wages, none of the wages are considered Social Security or Medicare wages, and neither the employee or the employer pay Social Security or Medicare taxes. If an employer is uncertain of the eventual amount, the appropriate employment taxes may be withheld and repaid to the employee in the event that the $1,800 threshold is not met.
Noncash wages--including the value of food, lodging, clothing, or any other noncash item given to an employee--are not considered Social Security or Medicare wages. Cash given to an employee to pay for those items is, however, considered cash wages.
Certain wages are not included in the definition of Social Security and Medicare wages (see IRS Publication 926):
* Wages paid to the employer's spouse
* Wages paid to the employer's child under the age of 21
* Wages paid to the employer's parent, except if--
* the parent cares for the employer's child, who is either under the age of 18 or has a physical or mental condition that requires the personal care of an adult for at least four continuous weeks in a calendar quarter, or
* the employer's marital status is divorced and not remarried, a widow or widower, or living with a spouse whose physical or mental condition prevents him from caring for the employer's child for at least four continuous weeks in a calendar quarter
* Wages paid to an employee who is younger than age 18 at any time during the year, except if providing household services is the employee's principal occupation. If the employee is a student, providing household services is not considered to be the principal occupation.
Withholding limit. There is a withholding limit for Social Security wages, but not Medicare wages. Social Security wages for 2013 are capped at $113,700 ($117,000 for 2014); no Social Security taxes are withheld from wages paid over this amount. Medicare taxes are withheld regardless of the worker's wages. The employer's matching share is not withheld from the employee's wages, but is paid from the employer's own funds.
Federal Unemployment Tax
The federal unemployment tax was enacted as part of the Federal Unemployment Tax Act (FUTA). It works in conjunction with state programs and pays unemployment compensation to workers who have become unemployed. Federal unemployment taxes and state unemployment taxes are not withheld from a worker's wages, but are paid out from an employer's funds.
The federal unemployment tax rate for 2013 is 6.0% of the employee's FUTA wages. A credit is generally available for up to 5.4%, so the net tax rate is 0.6%. The credit against the federal unemployment tax is available to employers paying state unemployment taxes. Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return, is used to compute the correct federal unemployment tax due.
The first $7,000 of cash wages for 2013 paid to each household employee is considered FUTA wages. An employer must have paid cash wages to all of their household employees of $1,000 or more in any calendar quarter of 2012 or 2013 in order to be required to pay FUTA taxes on the first $7,000 of cash wages. FUTA wages do not include wages paid to the employer's spouse, an employer's child younger than age 21, or an employer's parent.
Federal Income Tax Withholding
Employers are not required to withhold federal income tax from wages paid to household employees, but a household employee may request that federal income tax be withheld. Household employees making this request must give their employer a Form W-4, Employee's Withholding Allowance Certificate.
The employer must then refer to IRS Publication 15, Circular E, to determine the correct amount of federal income tax to withhold. Withholding is based on the employee's filing status and number of exemptions.
An employer can pay the employee's federal income taxes that would normally be withheld from the employer's funds. If an employer decides to pay the employee's federal income tax that would normally be withheld, these taxes must be included in the employee's wages for income tax, Social Security, Medicare, and FUTA purposes.
Wages subject to withholding. Wages subject to federal income tax withholding include both cash and noncash wages. Noncash wages are included at the fair market value of the noncash wage.
Meals provided to an employee at the employer's home for the employer's convenience do not constitute wages subject to withholding; neither does lodging provided at the employer's home for the employer's convenience and as a condition of employment.
Earned income credit (EIC). The EIC assists low-income taxpayers by allowing them to receive a payment from the IRS, even though little or no tax is actually owed. An employer must give an employee notice about the EIC if the employer withholds federal income tax from the employee's wages and the tax withholding tables determine that no tax should be withheld. The back of Copy B of Form W-2, Wage and Tax Statement, has a statement about the EIC that represents sufficient notice.
If a Copy B of Form W-2 is not utilized, then notice must be given to the worker using one of the following:
* A substitute Form W-2 with the same EIC information on the back of the employee's copy that is on Copy B
* Notice 797, Possible Federal Tax Refund Due to the Earned Income Credit (EIC)
* A written statement with the same wording as Notice 797.
Making Tax Payments
Schedule H (Form 1040) is used to compute Social Security, Medicare, FUTA, and withheld federal income taxes due to the IRS. Schedule H is attached to the employer's Form 1040. Any taxes from Schedule H are added to the employer's income tax. Schedule H taxes are not added to the employer's income tax on Form 1040 if the employer has paid the household employee's employment and income taxes withheld during the year.
Employers can pay the taxes during the year by--
* requesting their employer withhold additional federal income taxes from their wages,
* requesting the payer of their pension or annuity to withhold additional federal income taxes, or
* making estimated tax payments to the IRS.
Payment option for businesses and farms. Employers who also operates a trade or business or farm as a sole proprietor may include the employee and employer's share of employment taxes for their household workers with their employment taxes withheld and paid for their business or farm employees.
The employment taxes taken as a deduction on either Schedule C (Profit or Loss from Business) or Schedule F (Profit or Loss from Farming) would not include any wages and employment taxes for household employees.
A household employee's wages and withholdings need to be reported to the IRS if the employer pays wages subject to Social Security and Medicare withholdings, federal unemployment tax, or federal income tax withholdings. If employment taxes are reported on Schedule H, the employer will automatically receive the correct employer tax forms from the IRS for filing the next year.
Form SS-4. Employment tax forms ask for a nine-digit employer identification number (EIN). This is a different from the employer's Social Security number. If the employer does not have an EIN from a current trade or business, then an EIN should be requested by using Form SS-4, Application for Employer Identification Number. An EIN may be requested via mail, phone, or the Internet (http://www.irs.gov).
Form W-2. Each household worker must be given a Form W-2 if the following conditions are met:
* The employee was paid Social Security and Medicare wages for 2013 of $1,800 or more.
* The employee was paid wages that had federal income tax withheld.
Copy A of Form W-2 is sent to the Social Security Administration along with Form W-3, Transmittal of Wage and Tax Statements; Copies B, C, and 2 of Form W-2 are given to the employee. The electronic filing of these forms is encouraged.
Employees may request a Form W-2 at the time they terminate employment. This form must be given to the employee within 30 days of the request or when she leaves the employer.
Schedule H. Schedule H is used to report employment taxes if the household worker is paid the following:
* Social Security and Medicare wages for 2013 of $1,800 or more
* FUTA wages
* Wages from which the employer withheld federal income taxes.
Schedule H is filed with the employer's federal income tax return; however, if the employer is not required to file a federal income tax return, the employer can--
* file Schedule H without an attached federal income tax return, or
* include the employment taxes for the household worker with other employees on Form 941, Employer's Quarterly Federal Tax Return; Form 944, Employer's Annual Federal Tax Return; Form 943, Employer's Annual Federal Tax Return for Agricultural Employees; or Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return, whichever are applicable.
Various business employment tax returns. Similar to the second option noted above for nonfederal tax return filers, an employer can pay employment taxes for a household worker along with the employer's business or farm employment taxes and not file a Schedule H. Under this option, Social Security, Medicare, and any federal income taxes withheld are included on Form 941, Form 944, Form 943, or Form 940, whichever are applicable. if business employment tax returns are used instead of Schedule H, then the Form W-2 for the household worker is included with the Forms W-2 and W-3 for the business or farm workers.
Amending Schedule H. If an error is made on Schedule H, the process for amending it depends upon whether Schedule H was filed with other tax forms or as a stand-alone return. Form 1040X, Amended U.S. Individual Income Tax Return, is filed with a corrected Schedule H attached if Schedule H was previously filed with a Form 1040. If an error is discovered on a Schedule H that was filed as a stand-alone return, a corrected Schedule H is filed with "CORRECTED" and the date the error was found written on the top of the form.
If an underpayment of Social Security or Medicare taxes is being corrected, the underpayment must be paid by the time the corrected Schedule H is filed. For an underpayment, the corrected Schedule H is due not later than the due date of the next tax return after the error is discovered. If the corrected return is filed on time and the tax due paid, there will be no interest or penalties assessed. Interest is assessed on underreported FUTA taxes.
An overpayment of Social Security or Medicare taxes can either be adjusted or a claim for refund filed. For an overpayment, the corrected Schedule H is due within the refund period, which is generally within three years from the date the original form was filed or two years from the date the tax was paid, whichever is later. If a corrected Schedule H for an overpayment is filed within 90 days of the expiration of the period of limitations, only a claim for refund can be filed.
Procedures for Adjustments and Refund Claims for Overpayments
For a corrected Schedule H filed with a Form 1040X, the corrected return is adjusted by showing on line 22 of the Form 1040X that the overpayment is to be applied to the estimated taxes on Form 1040 for the year in which the corrected Schedule H is being filed. For a corrected Schedule H that was initially filed as a stand-alone return. "ADJUSTED" should be written on the top of the form. Interest is not paid on overpayments on adjusted returns. Overpayments of FUTA taxes may not be adjusted on a return. If a corrected Schedule H for an overpayment is filed within 90 days of the expiration of the period of limitations, only a claim for refund can be filed.
For a corrected Schedule H filed with a Form 1040X, the claim for refund is indicated on line 21. For a corrected Schedule H that was initially filed as a stand-alone return, the claim for refund is indicated by writing "REFUND" on the top of the form. Interest is paid for any refund overpayment Overpaid FUTA taxes are not refunded, but credits for state contributions are increased by the amount of the overpayment.
Failure to report employment taxes for household workers can result in both fines and imprisonment Internal Revenue Code (IRC) section 7201 states that any taxpayer who willfully attempts to evade a tax can be found guilty of a felony and fined up to $100,000, imprisoned for up to five years, or both. IRC section 7203 states that any taxpayer who will-filly fails to file a return, supply information, or pay a tax, can be found guilty of a misdemeanor and fined up to $25,000, imprisoned for up to one year, or both.
The employment of a worker who is not authorized to work in the United States carries a penalty ranging from $250 to $2,000 (8 USC 1324a[e]). If the taxpayer is shown to have a "pattern or practice" of hiring illegal aliens, the penalty can be a fine of up to $3,000 and a 6-month jail sentence (8 USC 1324a[f]). The employment of more than 10 known illegal workers in a 12-month period can result in a 5-month jail sentence (8 USC 1324a[A]).
Child and Dependent Care Credit
A federal tax credit is available to employers who incur employment-related child and dependent care expenses. These expenses must be incurred to enable the employer of the household worker to work or to seek employment. To be eligible, the employer must have either a dependent younger than age 13 or a dependent or spouse who is physically or mentally incapacitated and lives with the employer for more than six months of the year.
The expenses that are eligible for the tax credit include expenses incurred for household services and for the care of the qualifying individuals incurred to enable the employer to work. Both in-home and out-of-home expenses are eligible for the credit. Child or dependent care expenses paid to a relative are eligible for the credit, unless the relative is a child younger than age 19. The maximum amount of employment-related expenses eligible for the credit is $3,000 for one qualifying individual and $6,000 for two or more qualifying individuals.
The credit is subject to an earned income limit; eligible expenses cannot exceed the applicable limit. If the employer is married, the earned income limitation applies to the spouse with the lesser earned income. A "deemed" income is assigned to nonworking spouses who are physically or mentally disabled or are full-time students (enrolled full-time at an educational institution during five calendar months out of the year). The amount of deemed income is $250 per month if there is one qualifying individual or $500 per month if there are two or more qualifying individuals in the household.
The credit percentage is on a sliding scale from 20% to 35%, depending on the employer's adjusted gross income (AGO. The maximum credit of 35% applies to AGIs of $0 to $15,000; the minimum credit of 20% applies to AGIs greater than $43,000. The maximum eligible expenses are multiplied by the applicable credit percentage.
The child and dependent care credit is computed and reported with the employer's tax return using Form 2441, Credit for Child and Dependent Care Expenses (see IRS Publication 503, Child and Dependent Care Expenses).
Recordkeeping Of course, records must be maintained to show all of the information related to the household worker necessary to support the wages reported and any withholding. Records should be kept showing the worker's name, address, and Social Security number; the amount of all cash and noncash wages paid; any Social Security or Medicare taxes withheld or paid by the employer, any federal income tax withheld; and any state employment taxes withheld. Employment tax records should be kept for at least four years after the due date of the employer's tax return on which the taxes were reported or the date the taxes were paid, whichever is later.
All workers must have a Social Security number. Workers who do not have a Social Security number must apply for one using Form SS-5, Application for a Social Security Card. The request by the employer for a Social Security number must be no later than the first day on which wages are paid but preferably on the date the worker was hired. An employer should make a photocopy of the Social Security card in case a government agency investigates the matter at a later date.
In addition to state employment taxes, state law might require an employer to enroll in the workers' compensation plan. In addition, an employer might be required to obtain disability insurance for a household employee. Of course, employers should review their homeowner's insurance policy with respect to coverage for household workers.
No Small Matter
The average taxpayer is probably unaware of the tax and penalty consequences of hiring a household worker. But tax preparers and advisors must be aware of the tax aspects for domestic workers. The various tax and penalty issues discussed above need to be recognized and addressed whenever a taxpayer hires household help. While the taxpayer might see the amounts involved as insignificant, even a small amount of wages can be subject to a variety of taxes.
Larry R. Garrison, PhD, CPA, is the Helen Kemper/Missouri Professor of Accountancy in the Henry W. Bloch School of Management at the University of Missouri--Kansas City.
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|Title Annotation:||TAXATION federal taxation|
|Author:||Garrison, Larry R.|
|Publication:||The CPA Journal|
|Date:||Dec 1, 2013|
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