Knowing the Difference: Household Employee vs. Independent Contractor

Taxpayers who hire workers to perform household tasks could incur unexpected tax liabilities and penalties if they misclassify household employees as independent contractors. The correct classification of household workers is critical to properly reporting and paying state and federal employment-related taxes. To avoid unexpected tax liabilities and penalties, taxpayers should understand the classification and related tax reporting and tax payment obligations when hiring workers to perform household work.

Household Employee vs. Independent Contractor Classification

The Internal Revenue Service defines household work as “work done in or around your home” by babysitters, butlers, caretakers, cooks, domestic workers, drivers, health aides, housecleaning workers, housekeepers, maids, nannies, private nurses and yard workers. Whether someone hired to do household work is an employee or an independent contractor generally depends on their degree of control over the work.

Household employee: A worker is generally a household employee if the employer can control what work is done and how it is done. It does not matter how many hours were worked or whether the worker was paid on an hourly, daily, or weekly basis, or by the job. For example, a nanny is a household employee if the employer sets the nanny’s schedule, tells the nanny how to care for the children and provides the required childcare equipment.

Independent contractor: A worker is a self-employed independent contractor if the worker is the only one who controls how the work is done. Self-employed workers usually provide their own tools and offer services to the general public.

Worker hired through an agency: When a worker is hired through an agency, the degree of control still determines whether that worker is an employee or an independent contractor. The worker is a household employee if the employer can control what work is done and how it is done; by contrast, that worker is not a household employee if the agency controls the work.

Household Employee Tax Considerations

If a worker is classified as a household employee, the employer generally will have to pay Social Security and Medicare taxes and federal and state unemployment taxes on some or all of the wages paid to the household employee. In addition, if the employee requests and the employer agrees to do so, the employer should withhold federal income tax from the employee’s wages.

Social Security and Medicare Taxes

Both the employer and the household employee will generally owe Social Security and Medicare taxes on wages paid by the employer to the household employee. The employer’s share of these taxes is 7.65% (6.2% for Social Security tax and 1.45% for Medicare tax) of the employee’s Social Security and Medicare wages, and the employee’s share is the same amount.

Social Security wages for 2021 are cash wages of up to $142,800, and Medicare wages for 2021 are all cash wages (i.e., there is no cap on Medicare wages). However, if an employer pays a household employee less than $2,300 of cash wages in 2021, none of those wages are subject to Social Security tax or Medicare tax.

The employer should either withhold the employee’s share of Social Security and Medicare taxes from the wages paid to the household employee or pay those taxes on behalf of the employee. If the employer pays the household employee’s share of Social Security and Medicare taxes, the amount paid on behalf of the household employee constitute additional wages for federal income tax purposes (but not for Social Security tax and Medicare tax purposes).

Example: In 2021 Jill hired Jane to care for her child and agreed to pay Jane cash wages of $500 per week. Jane worked for 40 weeks in 2021, and Jill did not withhold any Social Security tax or Medicare tax from Jane’s wages (opting instead to pay those taxes on Jane’s behalf). Jane’s share of Social Security tax is $1,240 ($500 x 40 x 6.2%) and her share of Medicare tax is $290 ($500 x 40 x 1.45%). Since Jill is paying these taxes for Jane, Jane’s wages for federal income tax purposes are $21,530 ([$500 x 40] + $1,240 + $290). However, Jane’s Social Security and Medicare wages are only $20,000 ($500 x 40).

Unemployment Taxes

Federal and state unemployment taxes help to pay unemployment compensation to workers who lose their jobs. An employer of a household employee, like other employers, is generally subject to federal and state unemployment taxes on wages paid to a household employee.

The Federal Unemployment Tax Act (FUTA) imposes a federal unemployment tax (FUTA tax) on employers equal to 6 percent of an employee’s FUTA wages. If an employer pays cash wages of $1,000 or more in any calendar quarter of 2021, the first $7,000 of cash wages paid to each household employee in 2021 are FUTA wages. However, if an employer timely pays all of its state unemployment fund taxes (discussed next), the employer may be able to take a credit of up to 5.4 percent against the FUTA tax, resulting in a net FUTA tax rate of 0.6 percent (0.006).

States also impose unemployment taxes on employers of household employees. For example, in Texas, an employer must pay unemployment insurance tax on the first $9,000 of wages paid to each household employee in 2021.

Federal Income Tax

Employers are not required to withhold federal income tax from wages paid to household employees, but they can withhold federal income tax if the employee so requests and provides the employer with a completed Form W-4. An employer that withholds federal income tax is responsible for paying that tax to the U.S. Treasury.

Reporting and Payment Requirements

Employers of household employees must obtain an employer identification number (EIN) and file a separate Form W-2 for each household employee to whom they pay (1) wages subject to Social Security tax and Medicare tax, or (2) wages from which they withhold federal income tax. Individual employers must file Schedule H (Form 1040) to report the taxes due on the wages and any federal income tax withheld from the wages. The total tax due generally must be paid on or before the 15th day of the fourth month following the end of the individual employer’s tax year (i.e., by April 15, 2022, for tax year 2021). In order to avoid a penalty for underpayment of estimated tax, some or all of the taxes due on household employee wages may need to be paid via quarterly estimated tax payments.

Employment Eligibility Verification

When an employer hires a household employee, the employer and the employee should complete the U.S. Citizenship and Immigration Services Form I-9 (Employment Eligibility Verification). The employee should complete the employee section of the form by providing certain required information and attesting to his or her current work eligibility status in the United States. The employer should complete the employer section by examining documents presented by the employee as evidence of his or her identity and employment eligibility. The employer should keep the completed Form I-9 available for review upon request by an authorized U.S. Government official.

Negative Consequences

Misclassifying a household employee as an independent contractor can have negative consequences. The employer can be held liable for unpaid Social Security tax, Medicare tax, and federal and state unemployment taxes. The employer could also be subject to penalties for failing to timely pay these taxes, failing to file the appropriate tax forms (e.g., Form W-2 and Schedule H), and filing inaccurate income tax returns. Finally, the potential negative publicity associated with a “Nannygate” problem should not be overlooked.

For more information or questions on when a worker should be classified as a household employee, and the tax consequences associated with the classification, contact us. We’re here to help.

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