Household Employee vs. Contractor

That is the question.....

Many questions have risen in recent years regarding employees and independent contractors, specifically focusing on household employees.  Specific regulations have been set in place and many times, issues regarding household employees are brought to surface at the end of the employee relationship.  In our two part series, we answer some questions that apply to all variables of employment that you may find helpful.
 
Is the Individual an Employee?
 
The answer to this question will govern the reporting requirements for the individual.  As with most things involving tax, this question is not simple because the law requires an evaluation of the facts and circumstances surrounding the relationship.
 
The Department of Labor (DOL) uses a multi-factor reality test to determine the “employee status”:

1. The extent to which the work performed in an integral part of the employer’s business;
2. The worker’s opportunity for profit or loss depending on his or her managerial skills;
3. The extent of the relative investments of the employer and the worker;
4. Whether the work performed required special skills and initiative;
5. The permanency of the relationship; and
6. The degree of control exercised or retained by the employer

In addition to the DOL’s test, the Internal Revenue Service (IRS) defines an “employee” as a person who is an employee under the common law rules for determining the employer-employee relationship.  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 they are performed.  Three specific areas to consider when determining whether the individual is an employee are financial control, behavioral control, and the specific type of relationship between the parties.
 
If the answers to the control and relationship questions means the individual in not an employee, the individual will be an independent contractor who is therefore self-employed and responsible for his or her taxes, which means the reporting requirements for the individual are relatively straightforward.  If payments of $600 or more are made to any single individual, you as the employer, should prepare Form 1099-MISC, Miscellaneous Income, and provide to the independent contractor no later than January 31 of the year after the compensation was paid, as well as filed with the IRS.
 
If the individual is an employee, you as the employer, are responsible for a variety of taxes depending on the amount of wages paid and for the preparing and filing many federal and state forms (See “What Taxes do Employers Pay” in the second series of emails).
 
Is the Individual Eligible to Work in the U.S.?
 
This question particularly arises with household employers who employ caregivers or nannies.  You as the employer, must determine whether the individual can be employed in the United States.  Form I-9, Employment Eligibility Verification, must be completed by the individual and presented by the hire date.  The form requires the employer to examine documents that establish the worker’s identity and employment authorization.
 
The employer is not required to file Form I-9 with the government but should retain until the later of three years after the date of hire or one year after the employment relationship ends.  The U.S. Department of Homeland Security (DHS) offers a new online service called E-Verify to allow employers to check the immigration status of potential employees by comparing the information on Form I-9 to that of DHS and the Social Security Administration databases.  Employers who knowing employ individuals who are not eligible to work in the U.S. will face penalties for noncompliance with the Immigration Reform and Control Act of 1986 (IRCA).

The second part to this email series will address the employer's responsibility as well as the benefits to adhering to these regulations.  Keep an eye out for part two in the coming days.