Nannygate: an overview of payroll tax rules and immigration laws.
Many taxpayers, both individuals and businesses, have their first contact with the underground economy when they hire someone who does not report income to the IRS. Employers (who can be individuals or businesses) must withhold two types of federal payroll taxes from employees' wages: federal income taxes and Federal Insurance Contributions Act (FICA) taxes. Most employers also are liable themselves for two types of federal payroll taxes: Federal Unemployment Tax Act (FUTA) taxes and FICA taxes equal to the employees' FICA taxes. However, the withholding requirements and payroll taxes are not applicable if the service provider is considered to be an independent contractor. For the withholding rules and payroll taxes to apply, there must be an "employer-employee" relationship between the worker and the service purchaser.
Employer-employee relationship. For most taxpayers the existence of an employer-employee relationship depends primarily on the control the service purchaser retains over the manner in which the services are performed. In general, if the service purchaser has the right to control the details and means by which services are performed, an employer-employee relationship most likely exists. Unfortunately, there are few hard and fast rules. Every factor of each individual situation must be evaluated to make a reliable determination. To help taxpayers do this, the IRS has enumerated 20 factors it uses to distinguish employer-employee from other work relationships. Some of the more common factors are listed in exhibit 1[TABULAR DATA OMITTED], page 40.
These factors are not equally weighted; instead, the degree of importance of any one factor depends on the context in which the services are performed. Some factors therefore may be more important in certain situations than in others. If an employer-employee relationship exists, wages subject to federal payroll taxes generally include the fair market value of any property transferred or any noncash fringe benefits provided to the employee. Examples of noncash fringe benefits are meals (unless furnished on the employer's premises for their convenience) and clothing and services provided by the employer. In general, noncash fringe benefits not included in an employee's gross income, such as qualified employee discounts, are not subject to withholding tax.
Much of the recent concern over payroll taxes relates to the treatment of wages paid to domestic service employees. This includes wages paid for household services such as those provided by domestic workers, baby-sitters and gardeners. Illegal aliens often are hired to do such jobs, but as long as the services are performed in the United States, a worker's citizenship or residency status generally does not affect the applicability of federal income tax, FICA or FUTA withholding. Unfortunately, because the service purchaser in these circumstances usually has considerable control over the way work is done, an employer-employee relationship usually exists and payroll taxes apply.
Determining the employment status of a baby-sitter, housecleaner or gardener can be difficult at best because there are no specific guidelines for the situations usually encountered when hiring domestic workers. Based on informal discussions with its personnel, the IRS considers baby-sitters who work in the taxpayer's own house to be employees even if they do so infrequently. Housecleaners and gardeners who use their own tools and supplies are considered independent contractors by some, but individual housecleaners and gardeners who use the homeowner's tools and supplies apparently are considered the homeowner's employees even if they perform services only once a week.
To some extent, employment status might depend on the cost of the necessary tools and supplies. Housecleaners and gardeners who are part of a service with a number of workers are employees of the service, not of the homeowner. Taxpayers who are uncertain about a worker's status can submit Form SS-8, Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding, to the IRS. Using the information submitted, the IRS determines the worker's status. However, past IRS practice indicates filing an SS-8 may increase the risk of an employment audit.
The complexity in this area is increased by the special payroll tax rules that apply to domestic workers even if an employer-employee relationship does exist. Wages for domestic services are subject to federal income tax withholding if an employee requests withholding and the employer agrees; otherwise they are not. Domestic workers are, however, subject to FICA withholding if they are paid cash wages of $50 or more in a calendar quarter (on May 11 the House Ways and Means Committee voted to raise the threshold to $1,750 a year for domestic workers).
FICA taxes do not apply to noncash payments to domestic workers. FUTA taxes, on the other hand, do not apply to wages paid to domestics unless the employer pays cash wages of at least $1,000 during any calendar quarter of the current or preceding calendar year. If this threshold is met, both cash and noncash wages of domestics are subject to FUTA tax.
Federal income tax withholding. Employers are required to withhold federal income taxes from most employees' wages as and when they are paid. The withholding amount usually is determined using either the percentage method or the wage-bracket withholding method. Published tables (from IRS Publication 15) are used to determine the appropriate withholding amount based on the amount of periodic wages and the number of allowances claimed. Withholding also can be based on annualized wages, average estimated wages, cumulative wages or any other wage calculation method that results in withholding amounts that are substantially the same as those obtained using the percentage or wage-bracket methods.
FICA taxes. FICA laws require employers to pay an old age, survivor's and disability tax (OASDI) and a hospital insurance tax (HI), also known as the Medicare tax. These taxes are based on the amount of wages paid to each employee. FICA levies an equal tax on employees but requires the employer to withhold the employee's portion from his or her wages. If the employer fails to withhold the entire employee portion, the employer is still liable for the full amount.
For 1990 and later, the OASDI and HI tax rates are, respectively, 6.2% and 1.45% of wages paid to any employee. Both taxes currently apply only to a certain maximum dollar amount of wages, referred to as the wage base. The wage bases for both OASDI and HI taxes are automatically adjusted annually for inflation. In 1993, the wage bases for OASDI and HI taxes are $57,600 and $135,000, respectively. However, as of this writing President Clinton's economic recovery plan includes a provision that would eliminate the limit on wages subject to HI taxes.
FUTA taxes. In general, FUTA taxes are payable by any employer that (1) paid wages of $1,500 or more in any calendar quarter of the current or preceding calendar year or (2) employed at least 1 individual for some portion of a day in 20 separate weeks during the current or preceding calendar year. For agricultural labor, the $1,500 in (1) above is increased to $20,000 and the 1 individual in (2) is increased to 10 individuals. For household labor, the $1,500 in (1) above is changed to $1,000 of cash wages and there is no requirement corresponding to (2).
Through 1995, the FUTA tax rate is 6.2% of the first $7,000 of wages paid to each employee. For 1996 and later, the rate is scheduled to drop to 6%. However, employers can take a credit against their FUTA taxes for state unemployment taxes. This credit is 5.4% of the first $7,000 of wages, making the effective FUTA rate only .8% (6.2% - 5.4%). For employers that have shown they provide steady employment and therefore have decreased their state unemployment taxes, an additional credit is allowed. This credit cannot exceed the reduction in state unemployment taxes due to the employer's favorable employment history.
Reporting, payments and penalties. It often is the filing requirements, not the taxes themselves, that cause employers not to pay the appropriate payroll taxes. Employers that must withhold federal income and FICA taxes must file Form 941, Employer's Quarterly Tax Return. Sole proprietors who file form 941 for business employees also can include household employees. Otherwise, employers subject to federal income and FICA withholding taxes for household employees must file Form 942, Employer's Quarterly Tax Return for Household Employees. In addition to form 941 or 942, employers that must withhold FUTA taxes also must file Form 940 or Form 940-EZ, Employer's Annual Federal Unemployment (FUTA) Tax Return, by January 31 each year.
Employers must give each employee a Form W-2, Wage and Tax Statement, by January 31 and send a copy (along with Form W-3, Transmittal of Income and Tax Statements) to the Social Security Administration by the last day of February. If the worker is an independent contractor, the service purchaser must send the worker a Form 1099-MISC, Miscellaneous Income, by January 31 of the following year and send a copy (along with Form 1096, Annual Summary and Transmittal of U.S. Information Returns) to the IRS by February 28. If any of these dates falls on a weekend or holiday, the due date is the next regular weekday.
The employer must deposit amounts withheld for federal income, FICA and FUTA taxes with an authorized bank or Federal Reserve Bank accompanied by a completed Form 8109, Federal Tax Deposit Coupon. The required timing of the deposit depends on the amount of taxes withheld. For 1993 and later, new deposit rules require that if the tax reported on form 941 for the "lookback" period is $50,000 or less, monthly deposits of the calendar month's taxes must be made by the 15th day of the following month. (The lookback period for a calendar year corresponds to the first and second quarters of the previous year and the third and fourth quarters of the second previous year.)
All other depositors are semiweekly depositors who must make payments on Wednesdays and Fridays for taxes from the previous half-weeks ending on a Friday and a Tuesday, respectively. For 1993, employers still have the option of using the old deposit rules, under which the required deposit date can range from the end of the first month of the next quarter (for taxes of less than $500) to the first banking day following the current eighth month period (for more than $100,000). If unpaid FUTA taxes total over $100 at the end of any quarter, they must be deposited during the first month of the next quarter. An exception to the rules is allowed for employers that file form 942 for domestics' payroll taxes. These employers must deposit the taxes due on form 942 by the end of the month following any quarter in which cash wages paid for household services total $50 or more.
Penalties for failing to deposit withheld taxes depend on the number of days the deposit is late and range from 2% to 15% of the deposit due. The penalty for failing to file a tax return is 5% of the tax owed per month, up to a maximum of 25%. In addition to the failure-to-file penalty, there also is a penalty for failing to pay the tax due with a return of .5% of the tax due per month (1% after being served notice by the IRS), up to a maximum of 25%. The 5% faflure-to-file penalty is reduced by the .5% failure-to-pay penalty, resulting in a maximum combined penalty of 5% of the tax due per month. In addition to the above penalties there is a 100% penalty for failing to pay federal income tax and FICA taxes that have been withheld but not remitted to the IRS and that are not immediately collectible from the employer or business.
In the mid-1980s, economic problems in the United States, along with an increasing illegal alien population, led Congress to pass the Immigration Reform and Control Act of 1986 (IRCA). The act imposes penalties on any employer that hires or employs illegal aliens and applies to every employer and every employee in the United States-- whether full time, part time, casual, temporary or seasonal. It thus applies to all areas of employment, ranging from the hiring of the family housekeeper, gardener or babysitter to the hiring of engineers, doctors, lawyers, teachers or any other persons who may be classified as employees. IRCA imposes four duties on employers:
* Not to hire unauthorized aliens.
* To verify the identity and work authorization of every new employee.
* Not to discriminate on the basis of citizenship or national origin.
* To recognize the amnesty rights of certain illegal aliens who are eligible for temporary or permanent resident status in the United States.
Verification procedures. Because IRCA prohibits employers from hiring illegal aliens, it is necessary to verify the legal status of any potential employee. If initial verification indicates a person is authorized to work in the United States but the employee is eventually found to be an unauthorized alien, employment must be terminated. There are two exceptions to these requirements.
* Employers are not required to investigate workers who were employees before November 6, 1986.
* Employers are not required to discharge illegal aliens hired at a time when it was legal to employ them.
To verify the applicant's identity and authorization to work in the United States, an employer is required to examine certain documents that must be provided by the job applicant. Exhibit 2, page 42, identifies some of the documents that can be used to verify identity and employment eligibility. ... If an applicant cannot provide an item from the first column of exhibit 2, they must provide an item from both the second and third columns. Resident aliens can submit a green card (resident alien card) to show both identity and work authorization. After examining the documents submit Employment Eligibility Verification Form, attesting the proper documentation has been examined. The employee must sign and retain the form (as well as copies of the submitted documents) for three years after hire or one year after termination, whichever is later. The employer does not have to verify the authenticity of the employee's submitted documentation as long as each document appears on its face to be genuine.
Employment discrimination prohibition. Both IRCA and the Civil Rights Act of 1964 prohibit discrimination based on national origin. Under IRCA, employers with four or more employees also are prohibited from discriminating based on an applicant's citizenship status.
There are three exceptions to these anti-discrimination rules.
* They do not apply if English language skills are reasonably necessary to perform the job.
* They do not apply if a job has certain citizenship requirements specified by law, regulation, executive order or government contract or if there are citizenship requirements the U.S. attorney general determines are essential for doing business with the government.
* The act specifically permits employers to discriminate in favor of U.S. citizens over equally qualified legal aliens.
Penalties for failure to comply. IRCA mandates criminal an civil penalties for employers that knowingly hire illegal aliens. The civil penalties range from $250 to $2,000 per illegal alien employee for the first violation and $2,000 to $5,000 per illegal alien employee for a second violation. If the prosecutor can prove a pattern of such practice, the court may assess criminal penalties, including a fine of up to $3,000 for each unauthorized alien and imprisonment of up to six months.
Verifying a potential employee's legal status and maintaining related documentation can substantially increase an employer's administrative burden. In addition, the payroll tax withholding and reporting process can be onerous and time consuming, especially for smaller businesses and individuals hiring household help. However, the magnitude of the penalties, both monetary and professional (as in Ms. Baird's case), that can result from lack of compliance makes familiarity with them a necessity.
* EACH YEAR VAST AMOUNTS of income are unreported to the Internal Revenue Service. Unreported income for child care alone totals $11 billion, with much of the labor provided by undocumented aliens.
* THE TAX PROBLEMS OF then attorney general nominee Zoe Baird focused considerable attention on two misunderstood aspects of the law--payroll taxes and immigration.
* MANY AMERICANS DO NOT understand under what circumstances an employer-employee relationship exists when they hire workers to perform domestic services. The most significant factor appears to be the degree of control the employer exerts over how the employee performs his or her job.
* WHEN AN EMPLOYER-employee relationship does exist, employers are required to withhold certain taxes from the employee's wages, some of which require matching employer contributions.
* MANY TAXPAYERS FAIL to pay appropriate payroll taxes not because of the amounts involved but because of the complicated forms they must file.
* THE IMMIGRATION REFORM and Control Act of 1986 requires employers not to hire unauthorized aliens, to verify every new employee's identity and work authorization, not to discriminate on the basis of citizenship and national origin and to recognize certain illegal aliens are eligible to work.
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|Publication:||Journal of Accountancy|
|Article Type:||Cover Story|
|Date:||Jul 1, 1993|
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