About half of all American adults in their 40s and 50s are part of the "sandwich generation"; they have at least one parent who is 65 or older, and they're also raising a young child or financially supporting a grown child (Pew Research Center, "The Sandwich Generation: Rising Financial Burdens for Middle-Aged Americans"). These individuals face considerable pressure to balance the need to care for a multigenerational family with the obligation to earn a decent living. To manage these competing demands, many people are hiring in-home caregivers to help care for family members. As Baby Boomers continue to age and require more assistance, this need will likely grow. Not surprisingly, the U.S. Bureau of Labor Statistics (BLS) projects a 38% increase in employment in the home health and personal care sector in the coming decade (BLS, U.S. Department of Labor (DOL), Occupational Outlook Handbook, 2016—17 Edition, Home Health Aides.
Hiring a caregiver can be overwhelming. Amid dealing with the emotional and financial aspects of this task, many families overlook the tax and reporting obligations. When these oversights are discovered, the consequences can tarnish the reputations and diminish the finances of otherwise honest people. To help make the process of hiring a caregiver less burdensome, this article answers the tax and nontax questions that come up when a family hires someone to help in the home.
IS THE CAREGIVER AN EMPLOYEE?
The first question that must be answered is whether the caregiver is an "employee." The answer to this question will govern the reporting requirements for the caregiver. As with almost all things involving tax, this question is not simple because the law requires an evaluation of the facts and circumstances surrounding the family/caregiver relationship.
In the summer of 2015, the DOL issued new guidance on employee classification (Administrator's Interpretation No. 2015-1) based on an economic reality test founded upon both the Fair Labor Standards Act's (FLSA's) definition of the word "employ" and decisions from the Supreme Court and Circuit Courts of Appeals (see, e.g., Alamo Foundation, 471 U.S. 290 (1985), and Aimable v. Long and Scott Farms, 20 F.3d 434 (11th Cir. 1994)). Relying on the guidance provided by the FLSA and these cases, the DOL's multifactor test generally examines:
(A) the extent to which the work performed is an integral part of the employer's business; (B) the worker's opportunity for profit or loss depending on his or her managerial skill; (C) the extent of the relative investments of the employer and the worker; (D) whether the work performed requires special skills and initiative; (E) the permanency of the relationship; and (F) the degree of control exercised or retained by the employer. [Administrator's Interpretation No. 2015-1]
The DOL's memorandum is clear that the determination of the employment relationship is qualitative, not quantitative. As a result, the totality of the circumstances surrounding the relationship between the two parties is important.
In addition to the DOL's economic reality test, Internal Revenue Code Sec. 3121(d)(2) defines an "employee" as a person who is an employee under the common law rules for determining the employer-employee relationship. Regs. Sec. 31.3121(d)-1(c)(2) explains that this relationship exists when the person for whom services are performed has the right to control the actions of the person performing the services, determining not only which services are performed but also how. Rev. Rul. 87-41 provides detailed guidance by identifying 20 factors that describe the level of control, which indicates employment status. IRS Publication 15-A, Employer's Supplemental Tax Guide, distills this into three areas to consider in determining whether a caregiver is an employee. The three categories to examine are financial control, behavioral control, and the specific type of relationship between the parties.
If the answers to the control and relationship questions mean the caregiver is not an employee, he or she will be an independent contractor who is therefore self-employed and responsible for his or her taxes, which means the family's tax reporting requirements are relatively straightforward. If payments of $600 or more are made to any single caregiver, the family should prepare Form 1099-MISC, Miscellaneous Income, and report the amounts paid in box 7 as nonemployee compensation. (Filing a Form 1099-MISC is only required of taxpayers engaged in a trade or business; however, the authors recommend the filing of a Form 1099-MISC in order to protect the payer’s claims for credits or deductions.) Copies of Form 1099-MISC must be provided to the caregiver no later than Jan. 31 of the year after the compensation was paid, as well as filed with the IRS no later than that.
If the caregiver is an employee, the family is responsible for a variety of taxes depending on the amount of wages paid and for preparing and filing many federal and state forms.
IS THE CAREGIVER ELIGIBLE TO WORK IN THE U.S.?
Before dealing with the tax and other administrative requirements, the family must ascertain whether the caregiver can be employed in the United States. Form I-9, Employment Eligibility Verification, must be completed by the caregiver and presented to the family by the hire date. The form requires the family to examine documents that establish the worker's identity and employment authorization.
Form I-9 does not need to be filed with the government but should be retained until the later of three years after the date of hire or one year after the employment relationship ends. A new online service called E-Verify, which is offered by the U.S. Department of Homeland Security (DHS), allows employers to check the immigration status of potential employees by comparing the information on Form I-9 with the DHS and the Social Security Administration databases. While the use of this service is voluntary at the federal level, several states have mandated its use for certain large employers.
The Immigration Reform and Control Act (IRCA) of 1986 prohibits employers from knowingly employing individuals who are not eligible to work in the United States and specifies penalties for noncompliance (8 U.S.C. §1324a). As such, families are ill-advised to hire caregivers who are not eligible to work in the United States.
If an independent contractor relationship exists, the burden is eased significantly. IRCA prohibits employment but imposes a lower standard for independent contracting relationships. IRCA does not require verification of eligibility in independent contracting relationships, but a family that knowingly hires an ineligible individual as an independent contractor will be considered to have hired the individual as an employee, not as an independent contractor (see 8 U.S.C. §1324a(a)(4)).
Regardless of the immigration status of a caregiver that a family hires, both the family and the caregiver are still required to comply with the tax rules described below. To comply with the tax reporting rules, a caregiver can file Form W-7, Application for IRS Individual Taxpayer Identification Number, with the IRS to receive an individual taxpayer identification number (ITIN), which can be used by both the family and the caregiver for tax reporting purposes.
WHAT TAXES DO FAMILIES HAVE TO PAY?
When an in-home caregiver is considered an employee, a variety of federal and state laws require the family to (1) collect and remit the caregiver's withholding tax obligation; (2) collect and remit the caregiver's Social Security and Medicare (Federal Insurance Contributions Act, or FICA) tax obligations as well as pay the family's match of these taxes; (3) pay federal and state unemployment taxes on taxable wages; and (4) maintain appropriate records to support these filings.
Each caregiver should complete Form W-4, Employee's Withholding Allowance Certificate, to provide the family with the necessary federal income tax withholding information. Forms W-4 are not generally required to be submitted to the IRS but should be retained for at least four years. Depending on the wages and the exemptions claimed on Form W-4, federal income tax may need to be withheld. See IRS Publication 15, (Circular E), Employer's Tax Guide, to determine how much. Further, the family should consult state tax resources for the relevant state forms (i.e., the state equivalent of federal Form W-4) and to determine how much state income tax to withhold.
Families must also deal with a caregiver's FICA tax obligation—the Social Security tax of 6.2% on wages up to $118,500 in 2016 and the Medicare tax, which is imposed at a rate of 1.45% on all wages with no limit. Equivalent amounts of FICA taxes must be withheld from caregivers' wages when their annual wages are $2,000 or more during 2016. (Generally, any cash wages paid at any time during the year are not subject to this tax if paid to a spouse, child under age 21, parent, or any employee under the age of 18 performing household work (unless household work is the employee's principal occupation; if the employee is a student, providing household work is not considered to be his or her principal occupation).)
Other taxes may also apply. If cash wages paid in any calendar quarter exceed $1,000, the family will be subject to Federal Unemployment Tax Act (FUTA) taxes on up to $7,000 of wages. The FUTA rate is 6%, but generally, the family can take a credit against the FUTA tax for amounts paid into state unemployment funds. The credit may be as much as 5.4% of FUTA taxable wages. If the family is entitled to the maximum 5.4% credit, the FUTA tax rate after credit is 0.6%. A family is entitled to the maximum credit if:
- The family paid the required state unemployment taxes in full, on time, and on all the same wages as are subject to FUTA tax; and
- The state to which the taxes are paid is not determined to be a credit reduction state.
States impose unemployment taxes of varying rates on tax bases that range from $7,000 to $35,000 of wages paid. All states have an unemployment insurance agency or division of labor that can provide information necessary to comply with these rules.
Generally, families should use Form 1040, Schedule H, Household Employment Taxes, to report all of these federal taxes on the family member's individual income tax return and make any necessary estimated payments of tax using Form 1040-ES, Estimated Tax for Individuals. However, if the family runs a business as a sole proprietor and files Form 941, Employer's Quarterly Federal Tax Return, or Form 944, Employer's Annual Federal Tax Return, for business employees, or Form 943, Employer's Annual Federal Tax Return for Agricultural Employees, and Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return, the family may include taxes for household employees on these forms.
Forms 941 are due on the last day of the calendar month following the end of each respective calendar quarter; Forms 943 and 944 are due on Jan. 31 of the year following the tax year. Form 940 is generally due on the first day of the second month following year end. (Extensions may apply.)
Regardless of whether Schedule H or the alternative forms are used, the family will also need to provide the caregiver, the Social Security Administration, and the state taxing authority a completed Form W-2, Wage and Tax Statement, by Jan. 31. A completed Form W-3, Transmittal of Wage and Tax Statements, must accompany the Forms W-2 provided to the Social Security Administration. Household employers should check "Household Employee" in box b of Form W-3.
If an extension of time to file a Form W-2 is needed, an employer can file a request for a 30-day extension on Form 8809, Application for Extension of Time to File Information Returns, before the due date of Forms W-2. If granted, the extension is for 30 days, but the instructions to Form 8809 state that the IRS will only grant an extension in limited cases for extraordinary circumstances or catastrophe, such as a natural disaster or fire destroying the books and records needed for filing the forms. The IRS will grant only one extension of time to file.
Finally, the family should keep detailed records that support the tax filings for the in-home caregiver.
WHAT LABOR LAWS APPLY TO CAREGIVER EMPLOYEES?
The activities performed by an in-home caregiver most closely resemble "domestic service employment" as described in Section 13(a)(15) of the FLSA. Domestic service employees are generally afforded the minimum wage and overtime protections if they provide services that are regular and ongoing, generally more than 20 hours per week in the aggregate, and if they do not reside in the employer's household. These employees must be paid for all the time they spend at work, even if that time includes sleeping.
Employers that provide food, lodging, or other customary fringe benefits are entitled to include these items in compensation, provided the employee freely agrees to it (29 C.F.R. §531). Finally, the employer is required to keep, for at least three years, records, including the caregiver's name, complete address, Social Security number (SSN), total hours worked, total cash paid, weekly amounts claimed by the employer for board, lodging, or other facilities, and any overtime the caregiver worked (29 C.F.R. §552.110(a)).
If the caregiver lives with the family, the caregiver is allowed to be compensated differently. While the minimum wage rules continue to apply, the law contains an exemption from the overtime rules for domestic service employees who reside within the home where their services are provided (29 C.F.R. §552.102). In addition, the law provides that caregivers are not required to be compensated for times where they reside in the home but are not working, such as times for meals, sleep, or other free time, if an agreement about that time is reached between the employer and the caregiver and if the times involved are sufficient to allow the caregiver a reasonable amount of uninterrupted personal time (29 C.F.R. §§552.102, 785.23). If the meal periods, sleep time, or other periods of free time are interrupted by a call to duty, the interruption must be counted as hours worked.
In short, the FLSA protections require employers to be diligent about documenting how the caregiver is to be compensated and how noncash compensation (such as meals or lodging) factors into the total remuneration. Families can use an employment contract that provides a detailed job description, and if the caregiver lives with the family, when and how the hours worked by the caregiver are to be determined. In addition, families should take care to follow any state rules and regulations governing the employment relationship.
Since 1998, employers have been required by federal law to report information about newly hired employees to the state in which the employee works within a specified time period (42 U.S.C. §653a(b)(1)(A)). This new hire reporting is to aid the states in enforcing child support orders; employers should report to the state's new hire registration program.
WHAT INCOME TAX BENEFITS ARE AVAILABLE FOR EMPLOYERS?
In addition to avoiding unpleasant consequences of fines and other criminal punishments, the correct reporting of in-home caregiver taxes has several tax benefits, including the availability of the Sec. 21 child and dependent care tax credit. Families of children and the disabled need to work to earn a living, so Congress designed a credit for taxpayers who need outside help to care for a qualifying child or other qualifying person. In IRS Publication 503, Child and Dependent Care Expenses, the IRS summarizes the requirements for claiming this credit; the general point of the rules is that to take a credit for a person other than a qualifying child, the person must fit certain criteria (e.g., was physically or mentally unable to take care of himself or herself), the person claiming the credit must have earned income, and the caregiver must meet certain criteria (e.g., not be a dependent child of the taxpayer). If the services of the in-home caregiver meet these requirements, the taxpayer may claim a dependent care credit with a maximum of $3,000 for one dependent and $6,000 for two or more.
WHAT ELSE: DO I NEED INSURANCE?
Whether or not an in-home caregiver is considered to be an employee, the homeowner is well-advised to carry insurance. Workers' compensation laws are in place to protect workers' interests in the event they are injured on the job. While most states make workers' compensation insurance compulsory, some exempt small employers (those employing five or fewer employees). However, voluntary participation is permitted and well-advised.
The home health care industry has reported injury rates 70% higher than the national average for all occupations and 50% higher than the rates of similar care provided in hospitals ("Injuries to Caregivers Working in Patients' Homes," Issues in Labor Statistics, February 1997). The primary reason for these higher rates is the lack of assistive devices in the home for the care of the aged or infirm; the devices used in hospitals to move patients into and out of bed, for example, are frequently missing.
Minimizing the potential risk of economic loss to both the employer and the caregiver is very important. Workers' compensation insurance and/or an umbrella policy are vital to protect the employer's assets and to provide an income stream to the caregiver in the event of an accident.
Similarly, families need to make sure that their caregiver is bonded. Keeping in mind that the caregiver's workplace is the family's home, safeguarding family assets is very important. Securing a bond or some liability protection for the caregiver will afford both parties some reassurance.
IS WRITTEN DOCUMENTATION REQUIRED?
While written contracts are not required by federal law, state law varies on the subject of contracts for in-home caregivers and other domestic workers. In 2010, New York became the first state (and remains the only state at this writing) to require written contracts for domestic workers. Nonetheless, families in other states would also benefit from a contract. If the employer hires a caregiver through an agency, the agency may already have a contract ready for its clients.
One final caveat: While sample agreements are available through various websites, they should be viewed as guidelines. A final contract should be reviewed by legal counsel, not the family's CPA.
WHY COMPLY WITH THESE LAWS?
All of these laws, regulations, forms, and requirements may seem like an insurmountable obstacle. Understandably, some families are tempted to take the easier (but illegal) path of paying the caregiver "under the table." However, this approach is wrong for both the family and the caregiver. By ignoring relevant laws, families can be subjected to myriad legal penalties for failure to pay federal and state employment taxes in addition to having to pay the taxes themselves (see Notices 2004-13 and 2007-35).
To add insult to injury, these illegal payments would preclude the family from claiming the child and dependent care credit, denying them an otherwise legitimate tax benefit to reduce their income tax liability (Form 2441, Child and Dependent Care Expenses, requires the disclosure of the provider's name, address, identifying number (SSN or employer identification number), and the amount paid for qualified care).
Caregivers also lose out. "Failure to pay employment taxes is stealing from the employees," according to the IRS (IR 2004-47). The caregiver will lose unemployment and Social Security benefits because the unreported wages will not count toward otherwise valid benefits. The end of the employment relationship usually brings down this house of cards if the caregiver applies for unemployment benefits and the government discovers the reporting oversight.
About the authors
Brad Cripe (firstname.lastname@example.org) is an associate professor of accountancy, Katrina Mantzke (email@example.com) is the Donna R. Kieso Professor of Accountancy, and Christopher Bowen (Z171183@students.niu.edu) recently completed his Master of Accounting Science, all at Northern Illinois University in DeKalb, Ill.
To comment on this article or to suggest an idea for another article, contact Sally P. Schreiber, senior editor, at firstname.lastname@example.org or 919-402-4828.
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