So you’re finally springing for that nanny—or housekeeper or gardener—and you’ve decided to make it official in the eyes of the IRS.
What’s that, you say? You’re not sure you have to?
If you control both the work someone does and how she does it—as in the case, say, of a babysitter who comes to your house at the same time every week—she counts as an employee. And if you’re paying a household employee more than $1,800 a year, you’re required to withhold Social Security and Medicare taxes.
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Of course, there's an easy fix if you don't feel like dealing with a payroll to run your household: You could simply hire your staffers through a third-party agency. That way, your workers will be employees of that other company, not yours.
“I’ve always gone through an agency to hire somebody,” says LearnVest Planning Services certified financial planner™ Lorrie Minor, “because I don’t want to have to deal with these types of issues.”
All the same, if you do choose to hire your workers directly, we're here to show you how to make sure you're all buttoned up.
Take these steps to get your employee on the books:
1. Verify Eligibility
Before doing anything else, you have to make sure that your employee can legally work in the U.S. You can do this by having her fill out an I-9 form.
2. Get an EIN
An Employer Identification Number, that is. Now that you’re an employer, you’ll need this number for all the forms (all the forms!) you’ll be filling out and filing each year. Luckily, it’s not hard to get one. You can apply for one here.
3. Calculate Your Tax Bill
Just like any other employee, your worker will need to have Social Security and Medicare taxes withheld. That means withholding 7.65% of your employee’s salary from her paycheck and paying another 7.65% out of your own pocket.
To complicate matters, some employees will request that you pay their share of Social Security as well. “A number of employees will not work if they have to pay withholdings and Social Security taxes,” says Minor. If you choose to cover all or part of their taxes, whatever you pay will count as additional wages for your employee when it comes to income taxes (but it won't count for Social Security calculations).
Additionally, if you pay $1,000 or more to an employee in any quarter of the calendar year, you’ll owe federal unemployment taxes, or 6% on the first $7,000 she makes. (You can claim a tax credit for state unemployment taxes paid which could offset as much as 5.4% of it, which would leave a net 0.6%.)
Are your eyes crossing yet? You probably also will owe state unemployment taxes on your employee. Contact your state unemployment tax agency to see whether that’s the case. Find yours here.
Two more things: Starting in January, there’s an Additional Medicare Tax of 0.9% on the employee's income that's subject to the Medicare tax. But this tax only applies to money he or she makes in excess of $200,000 in a calendar year. (That would be a very well-paid babysitter, but you never know.)
4. Ask Whether Your Employee Wants to Withhold Taxes
Does your employee want you to withhold taxes from her paycheck? It will make it easier for her at tax time, but it will make her paycheck smaller in the near term. There are a number of calculators available to help you determine how much you should be setting aside for federal, state and local income taxes. Find one, for instance, at NannyTaxTools.com.
5. Think About Workers’ Comp
Workers’ compensation pays your employee’s salary if she’s injured on the job, and you may be required to have it, depending on your state. Find out which states require it here. Don’t be tempted to ignore this if it’s mandatory in your state, or you could face a hefty fine for any time period in which she worked for you but wasn’t covered.
You can typically buy workers’ comp as an add-on to your current homeowner’s or renter’s insurance policy. Costs will vary by location, from as little as $150 a year to $750 and up. Even in the event that it’s not required, it’s still a good idea, since it protects you from financial liability if your domestic employee gets hurt.
6. Stay on Top of Tax Deadlines
If you owe unemployment taxes (state or federal) or if your employee wants you to withhold taxes, you will, in turn, need to pay those amounts to the IRS and state in a timely manner. You can do so by making quarterly estimated tax payments to the federal and state tax authorities, or you can have your employer withhold extra taxes from your paycheck to cover the amount. (Find out how to do that here.)
State unemployment taxes will probably require a different process than state income taxes, so check with your state unemployment tax agency (see step 3) to see what that entails. “The real consideration here is that you make sure you’re paying enough taxes during the course of the year,” Minor says. If you wait until April to pay all of the taxes you withheld, you could owe underpayment penalties.
RELATED: I Want to Do My Taxes Checklist
7. Keep Good Records
It goes without saying. but we’re saying it: You should keep track of every form, payment and record that crosses your path. Experts suggest keeping all tax-related forms for up to seven years in case you’re audited by the IRS.
8. Do Your Taxes
In January, just like any employer, you’ll owe your employee a W-2 form. (Those records should come in handy now!) And come tax time, you’ll be adding an additional form to your stack: Schedule H, to report your household employment taxes. Find out how to manage both of those tasks in the Schedule H instructions, here.
All this might sound like a lot of work, but it doesn’t take much for a worker in your home to be considered an employee, and not doing this could result in serious consequences.
“I think a lot of people run into problems because they forget to go through these steps for the people who are earning extremely low compensation, such as the household employee who only comes a couple of times a month,” Minor says.
If someone who works for you should be paid as an employee and you’re not doing it, you could owe years of back taxes and penalties if the IRS catches on. Not to mention the fact that your employee isn’t protected if she becomes unemployed or hurt on the job, and her wages won’t count for future Social Security benefits.
In the end, we know that this whole process is a pain, but look on the bright side: Now you have a wonderful new nanny/babysitter/regular gardener, and you've financially protected that person and yourself.