After years of putting it off, my husband and I finally decided to hire a nanny to take care of our children after school. We could have taken the easy way out by using an outside service, but we really wanted to establish a long-lasting relationship with a qualified, caring individual I found on my own.
Fortunately, we found the right person. And, suddenly, we had to take a crash course in understanding what it means to be an employer. How to ensure that our nanny could legally work for us. How to set up a payroll system. How to calculate the taxes we’d need to withdraw from her paycheck.
Even though I am a financial planner, my experience and credentials didn’t fully prepare me for this new role. Fortunately, I was able to get great advice from my accountant and by reading useful publications like the IRS Household Employer’s Tax Guide.
If you’ve been thinking about hiring in-home help, whether it’s a nanny, housekeeper, maid, driver, personal chef, gardener or someone else, feel free to learn from my experiences in becoming a newly minted household employer.
Understanding the differences between “employee” and “self-employed”
It’s important for both you and your new hire to understand your working relationship, since you can both potentially get in trouble with the IRS if you don’t.
If this individual provides their own home, equipment or supplies, negotiates their work hours and responsibilities and gets paid as a 1099 contractor then the IRS treats them as self-employed and thus they are not an “employee.”
A household employee is someone whose schedule and responsibilities you personally manage. They use the resources you provide. But their work must specifically relate to the upkeeping of your home or in providing for the well-being of individuals residing there. This definition excludes certain categories of home-based workers such as private secretaries, tutors and music teachers.
What’s one of the first things you do when you start a new job? Fill out a Form I-9, which documents your eligibility to work. Our nanny had to do the same. She filled out the form and provided identification (in her case, a U.S. passport. If she didn’t have one, she could have provided her driver’s license and Social Security card). It’s my job to hold onto these forms (and copies of her identification) and make them available for inspection by authorized governmental authorities. The U.S. Citizenship and Immigration Services Form I-9 page can walk you through this process.
The payroll threshold
Generally, you only have to deal with payroll taxes if you pay your hired help more than $2,100 in a calendar year. However, in some cases, spouses and other family members taking on these roles can earn more than $2,100 without being taxed. These situations aren’t always straightforward, which is why you should always consult with a tax professional before any new employee starts working for you. Our nanny will be making much more than this, so I knew I’d need to get up to speed on the intricacies of payroll management pretty quickly.
As an employer, you need to make sure you’re handling your payroll responsibilities accurately and in compliance with federal and state laws. That’s why you might want to use payroll software designed for small businesses. These programs can calculate federal and state taxes, maintain records of filled out tax forms, pay your employee via checks or direct deposit and prepare year-end tax reports. Many of these programs offer basic functionality for free.
Becoming an IRS-recognized employer
If you’re going to be a household employer, you might as well be recognized as one. You can do this by applying for an Employer Identification Number (EIN) from the IRS. Note that you can’t use your Social Security number as an EIN.
Calculating payroll taxes
While your employee can pay their taxes on their own, to minimize the risk of underpayments and penalties it’s better for you to withhold taxes directly from their paychecks. The first step is for your new hire to fill out a W-4/Employee’s Withholding Certificate. While you’ll need to calculate the amount of federal income tax withheld based on the number of exemptions they choose, several tax rates will remain the same:
- The 12.4% Social Security tax, which is split between you and your employee, with each paying 6.2%.
- The 2.9% Medicare tax, also split between you and your employee, with each paying 1.45%.
- Federal unemployment tax of 6% on the first $7,000 of income. As employer, you pay this tax yourself, although in some cases you may be eligible for a 5.4% tax credit for unemployment tax you pay.)
You’ll need to keep immaculate records for every paycheck, including hours worked, amounts paid and taxes withheld. And every January, you’ll need to provide a W-2 wage and tax statement to your employee and file copy A with the IRS.
Don’t forget state taxes
Your state may require additional state income tax and other withdrawals from employee paychecks. And you need to stay current with changes in tax laws.
For example, in Massachusetts, where I live, the state income tax rate is being reduced from 5.05% in 2019 to 5% (starting in 2020) and the state unemployment tax rate is 2.4%. And in 2019 the state enacted the Paid Family and Medical Leave law, which levies a tax of 0.75% on each additional paycheck.
Beefing up your insurance
If our nanny gets injured on the job, I want to make sure that our homeowner’s insurance will cover her medical and loss-of-income claims. After calling my insurance provider, I discovered that I needed to add a special rider to get this extended coverage. Make sure you have the appropriate level of coverage before your new employee starts their first day of work.
Also keep in mind that many states require household employers to carry workers' compensation insurance in certain situations if they’re hiring nannies, housekeepers or other caregivers. For example, here in Massachusetts, household employers must get workers' compensation insurance if their domestic employees work 16 or more hours per week. Even if your state doesn’t require it, you may want to buy workers' compensation insurance anyway, since it may offer added protection for work-related injuries not covered by your homeowner’s insurance.
Deducting “nanny” expenses
If you’re hiring a nanny, you may be able to deduct as much as $3,000 per child ($6,000 maximum for two or more children) in childcare-related expenses, as long as both you and your spouse are working and your children are younger than 13 years old.
Or, if your company offers a Dependent Care Account (sometimes called a Dependent Care Flexible Spending Account), you may be able to make pre-tax contributions of up to $5,000 per year to help pay for qualified childcare expenses. Again, it’s important to talk to your tax professional to figure out which options offer the best tax benefits.
Unfortunately, these tax benefits are only available for those hiring childcare workers.
Meet with the experts
I already mentioned that you really should consult with your accountant or a tax professional before you hire your new household helper. But you may want to meet with a financial advisor as well. This combination of expertise not only can help you understand your responsibilities as an employer but can help you figure out how to adjust your cashflows to take on these added expenses and estimate your additional insurance needs.
This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.
This article was written by Joelle Spear, a financial advisor located at Canby Financial Advisors, 161 Worcester Road, Framingham, MA 01701. She offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. She can be reached at 508.598.1082 or [email protected]
©2019 Canby Financial Advisors