You may have seen Stephanie Breedlove featured in a Wall Street Journal story recently about “nanny tax amnesty.” The technical term the IRS is using is Voluntary Classification Settlement Program (VCSP) and this is very relevant to the household employment industry. In our experience, there are 2 common mistakes families make when hiring a household employee:

1) Misclassifying an employee as an “independent contractor” by giving them a Form 1099. (Worker misclassification is considered tax evasion for the family, increases the employee’s tax rate and limits her benefits).
2) Failing to withhold taxes and report wages properly. (Also known as “paying under the table,” the IRS considers this tax evasion too. It carries similar risk for the family and denies all benefits to the employee).

The VCSP helps with the first mistake because it is designed to allow employers who have misclassified their employee to come clean with very minimal penalties compared to what the IRS usually levies. By filling out the appropriate forms and paying the subsequent penalty, the employer agrees to treat the “independent contractor” as an employee moving forward and is not subject to an IRS audit. To take advantage of this amnesty offer, you must file by June 30, 2013.

For families currently paying “under the table,” Breedlove & Associates is happy to provide a simple, cost-effective solution that serves as an “amnesty program.” Lobbying on behalf of clients, we have an excellent track record of getting penalties waived for first-time offenders. As with any tax matter, it is much cheaper and easier to rectify a mistake if you come forward prior to an audit – and these “nanny tax” mistakes are prime examples of that IRS philosophy.

Over the years, the IRS and the state tax agencies have made it very clear that nannies, personal assistants, housekeepers and other domestic workers must be classified as employees of the family – not as independent contractors.

The distinction is not based on how many hours someone works, how much they’re paid, what type of work they perform or what they call themselves in a contract.  It is based on who’s deemed to be in control of the work relationship.

Independent contractors have control over how, when and by whom a job is performed.  On the other hand, employees follow the schedule and instructions established by the employer.

This seemingly subtle distinction matters because employer taxes are used to fund important worker benefits, such as unemployment. Additionally, misclassification costs the worker in terms of incremental tax burden; independent contractors are responsible for both the employee and employer portions of the FICA taxes, which add 7.65% to the worker’s tax responsibility.

Because of these financial implications, worker classification enforcement has become a focal point of state and federal tax agencies, who consider misclassification to be felony tax evasion. So it’s important that families understand the law and correctly report wages.  If someone tells you to “just 1099 her” beware; Form 1099 is the form that businesses use to report payments to an independent contractor. An employee’s wages should be reported using Form W-2.

To learn more about worker classification – or to correct a misclassification mistake – give us a call or visit our Expert Advice section.

When families become employers, they take on many of the same responsibilities that business employers do.  But unlike businesses, families don’t have accounting, legal and HR departments to expertly handle all the employment details.

Having served that role for more than 20,000 families since 1992 – many of whom came to us after problems arose – we’ve made a list of the most common tax and legal mistakes made by household employers.

MISTAKE: MISCLASSIFYING THE WORKER AS AN INDPENDENT CONTRACTOR

If you hire an individual to work in your home and you have the right to control what, when, how or by whom the work should be performed, the IRS considers that person to be your employee.  Misclassifying the worker as an independent contractor (by using Form 1099) is considered tax evasion.

In addition, workers who are misclassified as independent contractors have a larger tax burden and fewer government benefits than they do if they are correctly classified as employees.  To avoid tax and legal problems – and ensure that your employee receives all the take-home pay and government benefits to which she is entitled – families should follow the "nanny tax" compliance process outlined in IRS Publication 926 (click here for the compliance checklist).

Note: the IRS recently announced a major enforcement initiative in conjunction with the Department of Labor.  They are focused on collecting lost tax revenue due to misclassification and have targeted several industries, one of which is household employment.

MISTAKE: FAILURE TO PROPERLY ADDRESS OVERTIME

Nannies and other household employees are categorized as “Non-Exempt” workers under the Fair Labor Standards Act (FLSA).  That means their employer is required to pay overtime for all hours over 40 in a 7-day work week (live-in nannies are generally an exception to this rule, although a few states such as Massachusetts, Maryland, New York, Minnesota and Maine require live-in employees to be paid overtime as well). Overtime hours must be paid at a rate that is at least 1.5 times the regular rate of pay.

Many families try to side-step overtime by offering a salary.  In their minds, jobs that pay on a salary basis – instead of an hourly basis – are legally able to pay a fixed amount of wages regardless of how many hours the employee works.  This is true for employees categorized as “Exempt” under the FLSA (generally, “white-collar” professionals) because workers in these types of jobs are considered “well compensated” and “generally not prone to abuse.”  In other words, it’s the type of job – not the type of pay – that determines overtime requirements.  In the case of household workers, families must make sure to properly address overtime pay.

Note: If the worker and employer agree to a “salary” based on a schedule that regularly includes more than 40 hours, the family should protect themselves by addressing overtime in an employment agreement that is signed by the employee.  For example, family and nanny agree to $650 per week based on a 45-hour work week.  The employment agreement should specify that the weekly compensation is comprised of 40 hours at the regular rate of pay of $13.68/hour plus 5 hours at the overtime rate of $20.52/hour. Additionally, it must be stated that any hours over 45 in a work week will be paid at the overtime rate of $20.52.

MISTAKE: PUTTING A HOUSEHOLD EMPLOYEE ON THE COMPANY PAYROLL

This is a fairly common mistake for families who own a business.  The IRS does not consider household workers to be employees of the company because they are not “direct contributors” to its success.  And since businesses are entitled to tax deductions on payroll expense, it is an illegal tax deduction to include a domestic worker's payroll expense as part of the company payroll and tax reporting.

Instead, personal employees should be handled separately through the household employment reporting process.  If the expense is childcare related, the family can take the childcare tax breaks associated with those wages,but it must be handled on their personal income tax return.

Based on this same logic, it is considered insurance fraud to put a household employee on the company's group health plan.

MISTAKE: FAILURE TO PROPERLY WITHHOLD AND REPORT PAYROLL TAXES

Household employers are required to administer the payroll tax withholding and reporting process.  Sometimes employees will say – or imply – that they will “take care of their own taxes.”  Families, especially first-time employers, sometimes conclude that they are absolved of the tax responsibilities.  That is not the case; the state and federal tax agencies put the onus – and the liability – squarely on the employer.

MISTAKE: FAILURE TO SECURE A WORKER'S COMPENSATION POLICY

Workers' compensation is not part of the tax process.  It’s an insurance policy that provides financial assistance with lost wages and medical costs in the event that your employee has a work-related injury or illness.  It also protects employers from lawsuits since workers who accept benefits forfeit their right to sue the employer, regardless of fault.

Workers’ Compensation insurance is required for household employers in some states and optional in others (click here for the requirements by state).  If you are required to carry a workers' compensation policy – or if you elect to carry one – we suggest that you contact your homeowner's insurance agent.   If you’re not already covered, your agent can usually set up a policy over the phone.

Families who successfully handle these details don’t have to worry about potentially-expensive audits and lawsuits.  Additionally, they’re able to take advantage of childcare tax breaks that can offset – sometimes even exceed – the employer’s tax costs.  Finally, when paid correctly, the employee is entitled to important short-term and long-term benefits such as Social Security, Medicare, Unemployment, Disability and the ability to obtain loans/credit.

The Internal Revenue Service (IRS) and the Department of Labor (DOL) recently announced a partnership designed to crack down on worker misclassification -- that is, treating workers as independent contractors when they should be treated as employees.  A number of states have joined the enhanced enforcement initiative and others are expected to follow.

The reason?  Money.  Misclassification costs federal and state tax agencies billions of dollars each year in lost tax revenue.

While worker classification can be somewhat ambiguous in some industries, the IRS has ruled definitively on the household employment industry.  Nannies, housekeepers, health aides, personal assistants, estate managers and other domestic workers are all considered employees -- regardless of what they're called in a contract, how much they're paid, or how many hours a week they work.

Misclassifying these employees as independent contractors is considered tax evasion and includes back taxes, penalties and interest.  If you've had a household employee and been illegally giving her a Form 1099, now's the time to re-classify her as an employee and give her a Form W-2.  If you're worried about the cost or the paperwork, don't be; tax breaks make it much cheaper than you think and our service makes it effortless.  For more info, click here to take our brief video tour.

We’ve had lots of calls recently in which clients have been mis-advised to “1099 their nanny.”  (Form 1099 is the form used to report money paid to an independent contractor).  The IRS has ruled definitively on this subject: nannies ARE NOT independent contractors; they are employees of the families for whom they work.

By providing a 1099, the families misclassified their nannies, which is considered tax evasion and carries expensive penalties and legal problems.  In addition, it hurts the nanny financially because independent contractors have to pay an additional 7.65% in taxes (independent contractors pay the entire 15.3% in Social Security & Medicare taxes whereas employees only pay half).

If someone tells you to “just 1099 her,” ignore it and set them up as an employee.  You’ll be doing yourself and your nanny a big favor.