Tax Tip: How to Avoid Penalties on Your Household Helpers

If you employ someone to work for you around your house, it is important to consider the tax implications of this arrangement. While many people disregard the need to pay taxes on household employees, they do so at the risk of stiff tax penalties.

As you will see, these rules are quite complex, even for a relatively minor employee, and a mistake can bring on tax headaches.

Who Is a Household Employee?

The "nanny tax" rules apply to you only if (1) you pay someone for household work and (2) that worker is your employee.

  1. Household work is work done in or around your home by baby-sitters, nannies, health aides, private nurses, maids, caretakers, yard workers, and similar domestic workers.
  2. A household worker is your employee if you 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.

    On the other hand, if only the worker can control how the work is done, the worker is not your employee, but is self-employed. A self-employed worker usually provides his or her own tools and offers services to the general public in an independent business.

    Also, if an agency provides the worker and controls what work is done and how it is done, the worker is not your employee.

Example: You pay Betty to baby-sit your child and do light housework four days a week in your home. Betty follows your specific instructions about household and child care duties. You provide the household equipment and supplies that Betty needs to do her work. Betty is your household employee.

Example: You pay John to care for your lawn. John also offers lawn care services to other homeowners in your neighborhood. He provides his own tools and supplies, and he hires and pays any helpers he needs. Neither John nor his helpers are your household employees.

Can Your Employee Legally Work in the United States?

It is unlawful for you to knowingly hire or continue to employ an alien who cannot legally work in the United States.

When you hire a household employee to work for you on a regular basis, he or she must complete the employee part of the Immigration and Naturalization Service (INS) Form I-9, Employment Eligibility Verification. You must verify that the employee is either a U.S. citizen or an alien who can legally work, and then you must complete the employer part of the form. Keep the completed form for your records.

Tip: Two copies of Form I-9 are contained in the INS Handbook for Employers. Call the INS at 1-800-755-0777 to order the handbook or additional copies of the form or to get more information, or give us a call.

Do You Need to Pay Employment Taxes?

If you have a household employee, you may need to withhold and pay Social Security and Medicare taxes, or you may need to pay federal unemployment tax, or both. Refer to this table for details:

If you...

Then you need to...

Will pay cash wages of $1,700 or more in 2011 to any one household employee.Do not count wages you pay to: 

  • your spouse,
  • your child under age 21,
  • your parent, or
  • any employee under age 18 during 2011.
Withhold and pay Social Security and Medicare taxes. 

  • The combined taxes are generally 13.3% of cash wages.
  • Your employee's share is 5.65%.

(You can choose to pay the employee's share yourself and not withhold it.)

  • Your share is 7.65%.
Have paid or will pay total cash wages of $1,000 or more in any calendar quarter of 2010 or 2011 to household employees.Do not count wages you pay to: 

  • your spouse,
  • your child under age 21, or
  • your parent.
Pay federal unemployment tax. 

  • The tax is usually 0.8% of cash wages. After June 30, 2011, the tax is scheduled to decrease to 0.6% of cash wages.
  • Wages over $7, 000 a year per employee are not taxed.
  • You also may owe state unemployment tax.

If neither of these two contingencies applies, you do not need to pay any federal unemployment taxes. But you may still need to pay state unemployment taxes. (See below for more on this.)

You do not need to withhold federal income tax from your household employee's wages. But if your employee asks you to withhold it, you can choose to do so.

Tip: If your household employee cares for your dependent who is under age 13 or your spouse or dependent who is not capable of self-care, so that you can work, you may be able to take an income tax credit of up to 30% of your expenses. If you can take the credit, you can include your share of the federal and state employment taxes you pay, as well as the employee's wages, in your qualifying expenses.

State Unemployment Taxes

You should contact your state unemployment tax agency to find out whether you need to pay state unemployment tax for your household employee. You should also find out whether you need to pay or collect other state employment taxes or carry workers' compensation insurance.

Note: If you do not need to pay Social Security, Medicare, or federal unemployment tax and do not choose to withhold federal income tax, the rest of this article does not apply to you.

Social Security and Medicare Taxes

The Social Security tax pays for old-age, survivor, and disability benefits for workers and their families. The Medicare tax pays for hospital insurance.

Both you and your household employee may owe Social Security and Medicare taxes. Your share is 7.65% (6.2% for Social Security tax and 1.45% for Medicare tax) of the employee's Social Security and Medicare wages. Your employee's share is 4.2% for Social Security tax and 1.45% for Medicare tax.

You are responsible for payment of your employee's share of the taxes as well as your own. You can either withhold your employee's share from the employee's wages or pay it from your own funds. Note the limits in the table above.

Wages Not Counted

Do not count wages you pay to any of the following individuals as Social Security and Medicare wages:

  1. Your spouse.
  2. Your child who is under age 21.
  3. Your parent.

    Note: However, you should count wages to your parent if both of the following apply: (a) your child lives with you and is either under age 18 or has a physical or mental condition that requires the personal care of an adult for at least 4 continuous weeks in a calendar quarter, and (b) you are divorced and have not remarried, or you are a widow or widower, or you are married to and living with a person whose physical or mental condition prevents him or her from caring for your child for at least 4 continuous weeks in a calendar quarter.

  4. An employee who is under age 18 at any time during the year.

    Note: However, you should count these wages to an employee under 18 if providing household services is the employee's principal occupation. If the employee is a student, providing household services is not considered to be his or her principal occupation.

Also, if your employee's Social Security and Medicare wages reach $106,800 in 2011 or they did reach that level in 2010, do not count any wages you pay that employee during the rest of the year as Social Security wages to figure Social Security tax. (But continue to count the employee's cash wages as Medicare wages to figure Medicare tax.) You figure federal income tax withholding on both cash and non-cash wages (based on their value). However, do not count as wages any of the following items:

  • Meals provided at your home for your convenience.
  • Lodging provided at your home for your convenience and as a condition of employment.
  • Up to $230 a month in 2011 for transit passes that you give your employee or, in some cases, for cash reimbursement you make for the amount your employee pays to commute to your home by public transit. A transit pass includes any pass, token, fare card, voucher, or similar item entitling a person to ride on mass transit, such as a bus or train.
  • Up to $230 a month in 2011 to reimburse your employee for the cost of parking at or near your home or at or near a location from which your employee commutes to your home.

As you can see, the tax considerations for household employees are complex. Therefore, we highly recommend professional tax guidance in these complicated matters. This is definitely an area where it's better to be safe than sorry.

Please contact us for further information.