Don’t Ignore Household Employee Payroll Tax Rules

If you hire a domestic worker to provide services in or around your home, you probably have a tax liability that you don’t know about – or one that you do know about but are ignoring. Either situation can come back to bite you. When the worker is your employee, your liability includes both withholding and paying payroll taxes as well as issuing a W-2 after the close of the year.

Sure, it is a lot easier simply to pay your worker in cash so as to avoid federal and state payroll taxes – and all the paperwork that goes with them. Your domestic worker will likely be fully cooperative with a cash deal because he or she can also avoid paying taxes. However, if the IRS or your state employment department finds out about these payments, the result could be very unpleasant for you.

Not everyone who performs services in or around your home is classified as an employee. For instance, a plumber or electrician who makes repairs in your home will generally be a licensed contractor; the government does not classify contractors as employees.

On the other hand, the IRS has conclusively ruled that nannies, housekeepers, senior caregivers, some gardeners and various other domestic workers are employees of the people for whom they work. It makes no difference if you have a written contract with the employee; similarly, the number of hours worked and the amount paid do not matter.

You are probably thinking, “Wait a minute” – perhaps – everyone you know pays in cash, and none of them has paid payroll taxes or issued a W-2 for a household employee. However, if a worker gets injured on your property or if you dismiss the worker under less-than-amicable circumstances, it’s a pretty sure bet that your household employee will be the first one to throw you under the bus by reporting you to the state labor board or by filing for unemployment compensation.

Some individuals try to circumvent the payroll issue by treating a household employee as an independent contractor, incorrectly issuing the household employee a Form 1099-NEC.

Here are the correct actions you should take for domestic employees:

• Obtain a Federal Employer Identification Number (FEIN), which you will use in lieu of your Social Security Number when filing the required reporting forms. Note: If, as the owner of a sole proprietorship business, you already have a FEIN, you should use that number instead of requesting a separate one as a household employer. 
  
  
• Obtain a state ID number for unemployment insurance and state tax withholdings. 
  
  
• Withhold Social Security and Medicare taxes from the employee’s pay if it exceeds the annual threshold ($2,400 for 2022). 
  
  
• Withhold income tax from the employee if requested by the worker and if you agree to do so. 
  
  
• File state employment tax returns as required – generally quarterly (although beware that some states require monthly returns) – and make the required deposits for state employment taxes. 
  
  
• Prepare a W-2 for the employee and a W-3 transmittal; file them by the end of January. 
  
  
• File Schedule H with your federal individual income tax return and pay all the federal payroll and withholding taxes (i.e., the federal taxes that you withheld from the employee’s pay, plus your matching share of Social Security and Medicare taxes plus federal unemployment tax, which is entirely your responsibility). Limited exception: If you operate a sole proprietorship with employees, you may include the payroll taxes of your household workers with those of the business’s employees, but you cannot take a business deduction for those taxes. Generally, it is better to keep the personal and business reporting separate. 

Some additional issues to consider are as follows:

Please call this office if you would like assistance with your household employee tax and reporting requirements or with any special issues that apply to your state.