The Household Employee Problem

Don't get caught by the nanny tax

This often overlooked bookkeeping and payroll tax requirement can cause a tangle of tax problems if not handled correctly. Could you be impacted? This is what you need to know.

Nanny tax explained

In an effort to capture income from household employees, the tax code requires you to obtain employee information, pay the related state and federal taxes, and withhold taxes for anyone you employ around the house. The requirement comes into play if you pay any one individual $2,300 or more (in 2021). You must then submit a W-2 for each of these household employees.

Who is covered?

The household workers typically covered by this law include:

• babysitters
• caretakers
• house cleaners
• domestic workers
• drivers
• health aides
• housekeepers
• maids
• nannies
• private nurses
• yard workers

Employee or Not an Employee

Before you panic, first determine whether your help is an employee or not. If in the eyes of the tax code, your help is not an employee the nanny tax rules DO NOT apply. What does the IRS look for?

1. Who controls how the work is done? If the worker clearly does, then the person is self-employed and not your employee.
2. Whose tools are used? If the worker's tools are used then they are more likely self employed and not your household employee.
3. Work exclusively for you? If the worker has a number of customers then they are less likely to be your household employee.
4. Does an agency supply the worker? If an agency supplies the worker and controls what work is done and how it is done, the worker is not your employee.
5. Daycare services at an offsite location. If your childcare is conducted in the worker's home, that worker is generally not your employee.

Some Suggestions

• Have your help become incorporated. The reporting rule only applies to hired individuals. If your household help is in a LLC or Sub chapter S-Corporation, it is up to that company to employ the worker and pay their employment taxes.
• Be aware of the annual limit. Make sure your total payments do not exceed the reporting threshold each year.
• Determine if the hired help are truly employees or self-employed.
• Rotate services. If you have help with yard work consider employing a number of helpers to make sure no one person is paid above the reporting threshold.
• Make the determination now. If you think you may have a household employee, ask for a review. Waiting until the end of the year can create a reporting problem for tax payments due during the course of the year.
• Follow the IRS checklist. If you know you are hiring a qualified household employee, here is a brief checklist provided by the IRS to help keep you out of harm's way:

  • Find out if the person can legally work in the U.S. (form I-9)
  • Find out if you need to pay state taxes
  • Withhold social security and Medicare taxes
  • Withhold federal income tax if required
  • Determine if you are required to pay federal and/or state unemployment taxes
  • Determine the payment method and make tax payments
  • Get an employer identification number (EIN)
  • File W-2s each year and provide copies to your household employees
  • File household employment tax form with your annual tax return
  • Keep good records