A Word of Warning: In the past few weeks, we've seen several phishing scams disguised as IRS inquiries.  The emails, supposedly from the IRS, urgently request personal and financial information related to your tax situation.  Some have contained threats that failure to respond may have severe consequences.

Please remember that the IRS never initiates contact with taxpayers asking for personal and financial information.  If you get what looks like an IRS email, do not open the attachments and forward the email to phishing@irs.gov. 

Late yesterday, a House-Senate committee finalized a deal to extend the payroll tax holiday through the end of 2012.  (The payroll tax holiday is a temporary reduction in the employee's portion of the Social Security tax from 6.2% to 4.2%.  Combined with the 1.45% Medicare tax, the combined FICA tax for employees is 5.65% -- rather than the usual 7.65%).

The reduced Social Security tax has been in effect since the beginning of 2011, but without a Congressional deal, the holiday would have been discontinued at the end of February.

We get a lot of questions about health insurance.  As a household employer, do I have to cover health insurance for my nanny?  If I do provide it, are there any tax breaks to help offset the costs?

The answer to the first question is "No" -- health insurance is an optional benefit for families with a domestic employee(s).

On the second question, the answer is "Yes" -- household employers who decide to contribute to their employee's health insurance realize two tax advantages:

NON-TAXABLE COMPENSATION.  The employer's health insurance contribution is considered "non-taxable compensation," which means that neither the employer nor the employee have to pay any taxes on that portion of the compensation.

THE HEALTH INSURANCE TAX CREDIT FOR SMALL EMPLOYERS.  This recent legislation provides families with a tax credit of up to 35% of the health insurance contribution.  To qualify, employers must a) contribute at least 50% of the health insurance premium, b) have less than 25 employees, and c) pay their employees -- on average -- less than $50,000 per year.

Together, these two tax incentives can make health insurance a smart part of the compensation package for many families.  For an estimate of your savings, feel free to call us at 888-273-3356.

If you're a household employer and you've recently prepared and distributed a Form W-2 to your employee, don't forget that a copy of the W-2 needs to go to the Social Security Administration (SSA) by the end of February.  It's the employer's responsibility to file the 2011 W-2 Copy A and W-3 with the SSA on behalf of each employee who was paid $1,700 or more during 2011 (the 2012 threshold is $1,800).

This part of the "nanny tax" paperwork ensures that your employee receives the proper "earnings credits" from the SSA.  These credits are used to calculate the amount of benefits she will receive during retirement.  Retirement benefits are based on an income replacement formula that factors the worker's highest 35 years of earnings.  So, the greater her earnings credits, the more golden her golden years will be.

If you employed a domestic worker during 2011 and paid $1,700 or more, there are two important "nanny tax" deadlines that are quickly approaching:

Your state requires household employers to file employment tax returns by January 31.  (Your state may also require you to file an Annual Reconciliation as part of the year-end process).

You are required to prepare Form W-2 and distribute it to each employee no later than January 31.  (Important Note: Don't use Form 1099, which is for independent contractors.  The IRS has ruled that domestic workers should be classified as employees and misclassifying your employee as an independent contractor can expose you to felony tax evasion charges and expensive penalties).

If you're a Breedlove client, we have all your obligations covered.  If you're not a client and you want help meeting the state and federal deadlines, just complete our Secure Online Registration and we'll take care of everything. 

We've had a lot of calls in the last two weeks about nanny tax obligations.  Some families are hiring a household employee for 2012, while others are trying to get a Form W-2 and Schedule H prepared for wages paid in 2011.  If you want to learn more about the nanny tax obligations and how our household payroll service works, this nanny tax video will answer most of your questions in 3 minutes.  Or, feel free to give us a call at 1-888-273-3356.

As we posted a few weeks ago, California employers who hire after January 1, 2012 are required to provide their employee with specific employment-related information in writing.  It's required at the time of hire as well as anytime information changes.  Here's the form for your convenience: http://www.dir.ca.gov/dlse/LC_2810.5_Notice.pdf

When families become employers, they take on many of the same responsibilities that business employers do.  But unlike businesses, families don’t have accounting, legal and HR departments to expertly handle all the employment details.

Having served that role for more than 20,000 families since 1992 – many of whom came to us after problems arose – we’ve made a list of the most common tax and legal mistakes made by household employers.

MISTAKE: MISCLASSIFYING THE WORKER AS AN INDPENDENT CONTRACTOR

If you hire an individual to work in your home and you have the right to control what, when, how or by whom the work should be performed, the IRS considers that person to be your employee.  Misclassifying the worker as an independent contractor (by using Form 1099) is considered tax evasion.

In addition, workers who are misclassified as independent contractors have a larger tax burden and fewer government benefits than they do if they are correctly classified as employees.  To avoid tax and legal problems – and ensure that your employee receives all the take-home pay and government benefits to which she is entitled – families should follow the "nanny tax" compliance process outlined in IRS Publication 926 (click here for the compliance checklist).

Note: the IRS recently announced a major enforcement initiative in conjunction with the Department of Labor.  They are focused on collecting lost tax revenue due to misclassification and have targeted several industries, one of which is household employment.

MISTAKE: FAILURE TO PROPERLY ADDRESS OVERTIME

Nannies and other household employees are categorized as “Non-Exempt” workers under the Fair Labor Standards Act (FLSA).  That means their employer is required to pay overtime for all hours over 40 in a 7-day work week (live-in nannies are generally an exception to this rule, although a few states such as Massachusetts, Maryland, New York, Minnesota and Maine require live-in employees to be paid overtime as well). Overtime hours must be paid at a rate that is at least 1.5 times the regular rate of pay.

Many families try to side-step overtime by offering a salary.  In their minds, jobs that pay on a salary basis – instead of an hourly basis – are legally able to pay a fixed amount of wages regardless of how many hours the employee works.  This is true for employees categorized as “Exempt” under the FLSA (generally, “white-collar” professionals) because workers in these types of jobs are considered “well compensated” and “generally not prone to abuse.”  In other words, it’s the type of job – not the type of pay – that determines overtime requirements.  In the case of household workers, families must make sure to properly address overtime pay.

Note 1: If the worker and employer agree to a “salary” based on a schedule that regularly includes more than 40 hours, the family should protect themselves by addressing overtime in an employment agreement that is signed by the employee.  For example, family and nanny agree to $650 per week based on a 45-hour work week.  The employment agreement should specify that the weekly compensation is comprised of 40 hours at the regular rate of pay of $13.68/hour plus 5 hours at the overtime rate of $20.52/hour. Additionally, it must be stated that any hours over 45 in a work week will be paid at the overtime rate of $20.52.

Note 2: Overtime issues are particularly dangerous for employers because there is no statute of limitations, allowing former employees to file a wage dispute years after the relationship has terminated.  Back wages plus back taxes, penalties and interest can make this a very expensive mistake.  The good news is a simple employment agreement makes all the worries go away.

MISTAKE: PUTTING A HOUSEHOLD EMPLOYEE ON THE COMPANY PAYROLL

This is a fairly common mistake for families who own a business.  The IRS does not consider household workers to be employees of the company because they are not “direct contributors” to its success.  And since businesses are entitled to tax deductions on payroll expense, it is an illegal tax deduction to include a domestic worker's payroll expense as part of the company payroll and tax reporting.

Instead, personal employees should be handled separately through the household employment reporting process.  If the expense is childcare related, the family can take the childcare tax breaks associated with those wages,but it must be handled on their personal income tax return.

Based on this same logic, it is considered insurance fraud to put a household employee on the company's group health plan.

MISTAKE: FAILURE TO PROPERLY WITHHOLD AND REPORT PAYROLL TAXES

Household employers are required to administer the payroll tax withholding and reporting process.  Sometimes employees will say – or imply – that they will “take care of their own taxes.”  Families, especially first-time employers, sometimes conclude that they are absolved of the tax responsibilities.  That is not the case; the state and federal tax agencies put the onus – and the liability – squarely on the employer.

MISTAKE: FAILURE TO SECURE A WORKER'S COMPENSATION POLICY

Workers' compensation is not part of the tax process.  It’s an insurance policy that provides financial assistance with lost wages and medical costs in the event that your employee has a work-related injury or illness.  It also protects employers from lawsuits since workers who accept benefits forfeit their right to sue the employer, regardless of fault.

Workers’ Compensation insurance is required for household employers in some states and optional in others (click here for the requirements by state).  If you are required to carry a workers' compensation policy – or if you elect to carry one – we suggest that you contact your homeowner's insurance agent.   If you’re not already covered, your agent can usually set up a policy over the phone.

Families who successfully handle these details don’t have to worry about potentially-expensive audits and lawsuits.  Additionally, they’re able to take advantage of childcare tax breaks that can offset – sometimes even exceed – the employer’s tax costs.  Finally, when paid correctly, the employee is entitled to important short-term and long-term benefits such as Social Security, Medicare, Unemployment, Disability and the ability to obtain loans/credit.

As we wave good-bye to 2011, it's time to tidy up any loose ends on taxes.  If you hired someone to work in your home (i.e. nanny, nurse, housekeeper, chef, personal assistant, etc.) and paid them $1,700 or more, you have household employment tax obligations (a.k.a. "nanny taxes").  See Compliance Checklist for details.  Taking care of the reporting requirements has several benefits:

1) AUDIT & LAWSUIT PREVENTION.  Families who pay legally don't have to worry about audits, tax evasion charges or legal disputes levied by disgruntled former employees. Think of it as insurance against tax and legal problems.

2) TAX BREAKS. There is a common misperception that “nanny tax” compliance will be prohibitively expensive. The truth is most families with childcare expenses qualify for tax breaks that largely offset – sometimes even exceed – the employer tax costs. (See “Dependent Care Tax Breaks” for more details or visit our Employer Budget Calculator to get an estimate of your tax breaks).

3. PROFESSIONAL BENEFITS. When a family pays legally, the employee receives important short-term and long-term benefits, such as social security, medicare, unemployment, and an ability to obtain loans/credit. These benefits and protections have a dramatic impact on the perceived professionalism of the position and, therefore, the quality and duration of the employment relationship.

If you'd like to learn more about the Breedlove No-Work, No-Worry way to handle your obligations, watch this brief video or give us a call.  We're here to help.

Effective January 1, 2012, California families that employ a domestic worker (i.e. nanny, housekeeper, health aide, etc.) are required to provide each worker with a written wage notice at the time of hire.  Known as the California Wage Theft Prevention Act, the law mandates that the notice includes 1) the rate of pay, including overtime rates if applicable, 2) pay frequency, 3) employer information, including their formal name, address and phone number and 4) the name, address, and phone number of the employer's workers' compensation insurance carrier.

If you're preparing an employment agreement, we suggest including this information in the agreement.  If not, you can provide these details to your employee(s) in a separate document.