January 31, 2023 4:27 PM
For most tax practitioners, household employment is a tricky part of the Tax Code — primarily because of what they get from clients and when they get it.
Busy families who have nannies, senior caregivers, housekeepers, etc., are novices when it comes to employment administration and often wait until the tax year is over to take care of their household employer obligations. As a result, there’s usually a lot of cleanup.
The family more than likely failed to withhold FICA taxes from the employee’s pay. They probably never set up tax IDs or reported wages to the state throughout the year (as required by most states). As one of our accountant partners put it, household employment is a “big can of worms.”
Of course, these kinds of oversights and omissions can be resolved after the fact. But the cleanup is messier, especially on state-level obligations. And it’s always cheaper and easier to handle compliance proactively, but in 2023 that’s even more true.
While families are always well-advised to put their employee on the books at the time of hire, this year presents a handful of additional circumstances that are raising the stakes even more. Following the 2022 tax season, we highly recommend tax professionals proactively advise families to take care of any household employment obligations during the year. You’ll be doing your clients a big favor. It’s the only remedy that’s 100% effective at preventing “cans of worms.”
Here are five new reasons to try to get your clients to avoid a reactive mess next tax season:
Rising cost of care
Along with just about everything else, inflationary pressures have driven up wages for caregivers. In fact, the average full-time nanny now commands more than $36,000 per year, according to a 2022 Cost of Care Survey. This means that the financial implications of being delinquent are now more significant than ever before.
The potential looming recession is likely to create an increase in layoffs, which leads to an increase in unemployment claims and, therefore, a greater likelihood that “under the table” compensation gets exposed. The last time the U.S. had a major recession (2009), we saw a 2,000%-plus increase in unemployment insurance claims among household employees. The UI claims form requires the worker to list all employers and wage amounts in order to get benefits. That, in turn, creates a letter audit to collect state employment taxes and a referral to the IRS to collect federal employment taxes (FICA and FUTA).
Worker classification getting stricter
Worker classification tests continue to get stricter while enforcement continues to grow tighter. The reality is, tax agencies want the tax revenue and there’s a great deal of confusion among families about worker classification. Left to their own devices, many families will inadvertently misclassify their worker as an independent contractor (1099 instead of W-2). Penalties can be significant, especially with higher wage amounts now being paid to domestic workers.
Third-party payments have the attention of the IRS
Some families may continue paying their workers via a third-party payment processor (e.g. Venmo, PayPal, etc.), which will trigger 1099-K reporting for the 2023 tax year. This, of course, will create a large tax obligation that most domestic employees will not be able to cover. While this issue affects workers more than families, most experts predict that some desperate workers will push their families to provide them with a W-2 because the employer is then responsible for half of the 15.3% in FICA taxes. (Based on current wage rates, that saves the average employee almost $4,000 in FICA taxes).
HR issues will be more prevalent
Between state domestic worker bill of rights legislation and an ever-increasing number of state and municipal paid sick leave ordinances, we’re seeing a steady rise in time-consuming and expensive HR issues (overtime, wage notice requirements, paid sick leave, etc.). It’s more important than ever to set up payroll and accruals correctly at the time of employment and make sure that someone is monitoring all the local, state and federal changes.
Senior Director, Care.Com HomePay