How to Avoid Penalties on Your Household Helpers

If you employ someone to work for you around your house, it is important to consider the tax implications of this arrangement. While many people disregard the need to pay taxes on household employees, they do so at the risk of stiff tax penalties.

As you will see, these rules are quite complex, even for a relatively minor employee, and a mistake can bring on tax headaches.

Who Is a Household Employee?

The "nanny tax" rules apply to you only if (1) you pay someone for household work and (2) that worker is your employee.

1. Household work is work done in or around your home by baby-sitters, nannies, health aides, private nurses, maids, caretakers, yard workers, and similar domestic workers.

2. A household worker is your employee if you control not only what work is done, but how it is done.

   If the worker is your employee, it does not matter whether the work is full-time or part-time, or that you hired the worker through an agency or from a list provided by an agency or association. It also does not matter whether you pay the worker on an hourly, daily, or weekly basis, or by the job.

   On the other hand, if only the worker can control how the work is done, the worker is not your employee, but is self-employed. A self-employed worker usually provides his or her own tools and offers services to the general public in an independent business.

   Also, if an agency provides the worker and controls what work is done and how it is done, the worker is not your employee.

Example: You pay Betty to baby-sit your child and do light housework four days a week in your home. Betty follows your specific instructions about household and child care duties. You provide the household equipment and supplies that Betty needs to do her work. Betty is your household employee.

Example: You pay John to care for your lawn. John also offers lawn care services to other homeowners in your neighborhood. He provides his own tools and supplies, and he hires and pays any helpers he needs. Neither John nor his helpers are your household employees.

Can Your Employee Legally Work in the United States?

It is unlawful for you to knowingly hire or continue to employ an alien who cannot legally work in the United States.

When you hire a household employee to work for you on a regular basis, he or she must complete the employee part of the Immigration and Naturalization Service (INS) Form I-9, Employment Eligibility Verification. You must verify that the employee is either a U.S. citizen or an alien who can legally work, and then you must complete the employer part of the form. Keep the completed form for your records.

Tip: Two copies of Form I-9 are contained in the INS Handbook for Employers. Call the INS at 1-800-755-0777 to order the handbook or additional copies of the form or to get more information, or give us a call.

Do You Need to Pay Employment Taxes?

If you have a household employee, you may need to withhold and pay Social Security and Medicare taxes, or you may need to pay federal unemployment tax, or both. Refer to this table for details:

If you...	Then you need to...
Will pay cash wages of $1,700 or more in 2011 to any one household employee. Do not count wages you pay to: your spouse, your child under age 21, your parent, or any employee under age 18 during 2011.	Withhold and pay Social Security and Medicare taxes. The combined taxes are generally 13.3% of cash wages. Your employee's share is 5.65%. (You can choose to pay the employee's share yourself and not withhold it.) Your share is 7.65%.
Have paid or will pay total cash wages of $1,000 or more in any calendar quarter of 2010 or 2011 to household employees. Do not count wages you pay to: your spouse, your child under age 21, or your parent.	Pay federal unemployment tax. The tax is usually 0.8% of cash wages. After June 30, 2011, the tax is scheduled to decrease to 0.6% of cash wages. Wages over $7, 000 a year per employee are not taxed. You also may owe state unemployment tax.

If neither of these two contingencies applies, you do not need to pay any federal unemployment taxes. But you may still need to pay state unemployment taxes. (See below for more on this.)

You do not need to withhold federal income tax from your household employee's wages. But if your employee asks you to withhold it, you can choose to do so.

Tip: If your household employee cares for your dependent who is under age 13 or your spouse or dependent who is not capable of self-care, so that you can work, you may be able to take an income tax credit of up to 30% of your expenses. If you can take the credit, you can include your share of the federal and state employment taxes you pay, as well as the employee's wages, in your qualifying expenses.

State Unemployment Taxes

You should contact your state unemployment tax agency to find out whether you need to pay state unemployment tax for your household employee. You should also find out whether you need to pay or collect other state employment taxes or carry workers' compensation insurance.

Note: If you do not need to pay Social Security, Medicare, or federal unemployment tax and do not choose to withhold federal income tax, the rest of this article does not apply to you.

Social Security and Medicare Taxes

The Social Security tax pays for old-age, survivor, and disability benefits for workers and their families. The Medicare tax pays for hospital insurance.

Both you and your household employee may owe Social Security and Medicare taxes. Your share is 7.65% (6.2% for Social Security tax and 1.45% for Medicare tax) of the employee's Social Security and Medicare wages. Your employee's share is 4.2% for Social Security tax and 1.45% for Medicare tax.

You are responsible for payment of your employee's share of the taxes as well as your own. You can either withhold your employee's share from the employee's wages or pay it from your own funds. Note the limits in the table above.

Wages Not Counted

Do not count wages you pay to any of the following individuals as Social Security and Medicare wages:

1. Your spouse.

2. Your child who is under age 21.

3. Your parent.

Note: However, you should count wages to your parent if both of the following apply: (a) your child lives with you and is either under age 18 or has a physical or mental condition that requires the personal care of an adult for at least 4 continuous weeks in a calendar quarter, and (b) you are divorced and have not remarried, or you are a widow or widower, or you are married to and living with a person whose physical or mental condition prevents him or her from caring for your child for at least 4 continuous weeks in a calendar quarter.

4. An employee who is under age 18 at any time during the year.

Note: However, you should count these wages to an employee under 18 if providing household services is the employee's principal occupation. If the employee is a student, providing household services is not considered to be his or her principal occupation.

Also, if your employee's Social Security and Medicare wages reach $106,800 in 2011 or they did reach that level in 2010, do not count any wages you pay that employee during the rest of the year as Social Security wages to figure Social Security tax. (But continue to count the employee's cash wages as Medicare wages to figure Medicare tax.) You figure federal income tax withholding on both cash and non-cash wages (based on their value). However, do not count as wages any of the following items:

• Meals provided at your home for your convenience.

• Lodging provided at your home for your convenience and as a condition of employment.

• Up to $230 a month in 2011 for transit passes that you give your employee or, in some cases, for cash reimbursement you make for the amount your employee pays to commute to your home by public transit. A transit pass includes any pass, token, fare card, voucher, or similar item entitling a person to ride on mass transit, such as a bus or train.

• Up to $230 a month in 2011 to reimburse your employee for the cost of parking at or near your home or at or near a location from which your employee commutes to your home.

As you can see, the tax considerations for household employees are complex. Therefore, we highly recommend professional tax guidance in these complicated matters. This is definitely an area where it's better to be safe than sorry.

Please contact us for further information.

Haven't Filed an Income Tax Return? What to Do

Filing a past due return may not be as difficult as you think.

Taxpayers should file all tax returns that are due, regardless of whether full payment can be made with the return. Depending on an individual's circumstances, a taxpayer filing late may qualify for a payment plan. It is important, however, to know that full payment of taxes upfront saves you money.

Here's What to Do When Your Return Is Late

Gather Past Due Return Information

Gather return information and come see us. You should bring any and all information related to income and deductions for the tax years for which a return is required to be filed.

Payment Options - Ways to Make a Payment

There are several different ways to make a payment on your taxes. Payments can be made by credit card, electronic funds transfer, check, money order, cashier's check, or cash.

Payment Options - For Those Who Can't Pay in Full

Taxpayers unable to pay all taxes due on the bill are encouraged to pay as much as possible. By paying as much as possible now, the amount of interest and penalties owed will be lessened. Based on the circumstances, a taxpayer could qualify for an extension of time to pay, an installment agreement, a temporary delay, or an offer in compromise.

Taxpayers who need more time to pay can set up either a short-term payment extension or a monthly payment plan.

• A short-term extension gives a taxpayer up to 120 days to pay. No fee is charged, but the late-payment penalty plus interest will apply.
• A monthly payment plan or installment agreement gives a taxpayer more time to pay. However, penalties and interest will continue to be charged on the unpaid portion of the debt throughout the duration of the installment agreement/payment plan. In terms of how to pay your tax bill, it is important to review all your options; the interest rate on a loan or credit card may be lower than the combination of penalties and interest imposed by the Internal Revenue Code. You should pay as much as possible before entering into an installment agreement.
• A user fee will also be charged if the installment agreement is approved. The fee, normally $105, is reduced to $52 if taxpayers agree to make their monthly payments electronically through electronic funds withdrawal. The fee is $43 for eligible low-and-moderate-income taxpayers.

What Will Happen If You Don't File Your Past Due Return or Contact the IRS

It's important to understand the ramifications of not filing a past due return and the steps that the IRS will take. Taxpayers who continue to not file a required return and fail to respond to IRS requests for a return may be considered for a variety of enforcement actions.

Please contact us for further information and support on your late returns.

Employee or Independent Contractor - Which Is It?

If you hire someone for a long-term, full-time project or a series of projects that are likely to last for an extended period, you must pay special attention to the difference between independent contractors and employees.

Why It Matters

The Internal Revenue Service and state regulators scrutinize the distinction between employees and independent contractors because many business owners try to categorize as many of their workers as possible as independent contractors rather than as employees. They do this because independent contractors are not covered by unemployment and workers' compensation, or by federal and state wage, hour, anti-discrimination, and labor laws. In addition, businesses do not have to pay federal payroll taxes on amounts paid to independent contractors.

Caution: If you incorrectly classify an employee as an independent contractor, you can be held liable for employment taxes for that worker, plus a penalty.

The Difference Between Employees and Independent Contractors

Independent Contractors are individuals who contract with a business to perform a specific project or set of projects. You, the payer, have the right to control or direct only the result of the work done by an independent contractor, and not the means and methods of accomplishing the result.

Example: Sam Smith, an electrician, submitted a job estimate to a housing complex for electrical work at $16 per hour for 400 hours. He is to receive $1,280 every 2 weeks for the next 10 weeks. This is not considered payment by the hour. Even if he works more or less than 400 hours to complete the work, Sam will receive $6,400. He also performs additional electrical installations under contracts with other companies that he obtained through advertisements. Sam Smith is an independent contractor.

Employees provide work in an ongoing, structured basis. In general, anyone who performs services for you is your employee if you can control what will be done and how it will be done. A worker is still considered an employee even when you give them freedom of action. What matters is that you have the right to control the details of how the services are performed.

Example: Sally Jones is a salesperson employed on a full-time basis by Rob Robinson, an auto dealer. She works 6 days a week, and is on duty in Rob's showroom on certain assigned days and times. She appraises trade-ins, but her appraisals are subject to the sales manager's approval. Lists of prospective customers belong to the dealer. She has to develop leads and report results to the sales manager. Because of her experience, she requires only minimal assistance in closing and financing sales and in other phases of her work. She is paid a commission and is eligible for prizes and bonuses offered by Rob. Rob also pays the cost of health insurance and group term life insurance for Sally. Sally Jones is an employee of Rob Robinson.

Independent Contractor Qualification Checklist

The IRS, workers' compensation boards, unemployment compensation boards, federal agencies, and even courts all have slightly different definitions of what an independent contractor is, though their means of categorizing workers as independent contractors are similar.

One of the most prevalent approaches used to categorize a worker as either an employee or independent contractor is the analysis created by the IRS. The IRS considers the following:

1. What instructions the employer gives the worker about when, where, and how to work. The more specific the instructions and the more control exercised, the more likely the worker will be considered an employee.

2. What training the employer gives the worker. Independent contractors generally do not receive training from an employer.

3. The extent to which the worker has business expenses that are not reimbursed. Independent contractors are more likely to have unreimbursed expenses.

4. The extent of the worker's investment in the worker's own business. Independent contractors typically invest their own money in equipment or facilities.

5. The extent to which the worker makes services available to other employers. Independent contractors are more likely to make their services available to other employers.

6. How the business pays the worker. An employee is generally paid by the hour, week, or month. An independent contractor is usually paid by the job.

7. The extent to which the worker can make a profit or incur a loss. An independent contractor can make a profit or loss, but an employee does not.

8. Whether there are written contracts describing the relationship the parties intended to create. Independent contractors generally sign written contracts stating that they are independent contractors and setting forth the terms of their employment.

9. Whether the business provides the worker with employee benefits, such as insurance, a pension plan, vacation pay, or sick pay. Independent contractors generally do not get benefits.

10. The terms of the working relationship. An employee generally is employed at will (meaning the relationship can be terminated by either party at any time). An independent contractor is usually hired for a set period.

11. Whether the worker's services are a key aspect of the company's regular business. If the services are necessary for regular business activity, it is more likely that the employer has the right to direct and control the worker's activities. The more control an employer exerts over a worker, the more likely it is that the worker will be considered an employee.

Minimize the Risk of Misclassification

If you misclassify an employee as an independent contractor, you may end up before a state taxing authority or the IRS.

Sometimes the issue comes up when a terminated worker files for unemployment benefits and it's unclear whether the worker was an independent contractor or employee. The filing can trigger state or federal investigations that can cost many thousands of dollars to defend, even if you successfully fight the challenge.

There are ways to reduce the risk of an investigation or challenge by a state or federal authority. At a minimum, you should:

• Familiarize yourself with the rules. Ignorance of the rules is not a legitimate defense. Knowledge of the rules will allow you to structure and carefully manage your relationships with your workers to minimize risk.

• Document relationships with your workers and vendors. Although it won't always save you, it helps to have a written contract stating the terms of employment.

If you have any questions about how to classify your employees, please give us a call. We can help guide you in the right direction in the eyes of the IRS.

Looking for Your Tax Refund?

You can go online to check the status of your 2010 refund 72 hours after the IRS acknowledges receipt of your e-filed return, or 3 to 4 weeks after you mail a paper return. Be sure to have a copy of your 2010 tax return available because you will need to know your filing status, the first Social Security number shown on the return, and the exact whole-dollar amount of the refund. You have three options for checking on your refund:

• Go to IRS.gov, and click on "Where's My Refund"

• Call 1-800-829-4477 24 hours a day, seven days a week for automated refund information

• Call 1-800-829-1954 during the hours shown in your tax form instructions

How to Spot an IRS Impersonation Scheme

The IRS does not send taxpayers unsolicited e-mails about their tax accounts, tax situations, or personal tax issues. If you receive such an e-mail, most likely it's a scam.

IRS impersonation schemes flourish during filing season. These schemes may take place via phone, fax, Internet sites, social networking sites, and particularly e-mail.

Many impersonations are identity theft scams that try to trick victims into revealing personal and financial information that can be used to access their financial accounts. Some e-mail scams contain attachments or links that, when clicked, download malicious code (a virus) that infects your computer or directs you to a bogus form or site posing as an IRS form or Web site.

Some impersonations may be commercial Internet sites that consumers unknowingly visit, thinking they're accessing the genuine IRS Web site, IRS.gov. However, such sites have no connection to the IRS.

If you want to know whether a site is legitimate or you think you have been the victim of fraud, please contact us. We definitely don't want you to get scammed.

Employers Must Now Report Health Care Benefits

Under the Affordable Health Care Act, employers are now required to report the value of health care benefits. Beginning in 2011, employers must report the value of health care benefits for each employee. This amount will appear on the new 2011 form W-2 to be issued in 2012. This is a reporting item and will not affect taxable income.

To give employers more time to update their payroll system, the IRS has made this requirement optional for 2011. For small businesses with fewer than 250 employees, it will remain optional for 2012.

If you have questions about this requirement, please contact our office.

Check Out Exemptions and Deductions for 2011

With the 2010 tax filing deadline behind us, it's time to plan for 2011.

The standard and itemized deductions for 2011 are as follows:

Standard Deduction for 2011:

• $5,800 for unmarried taxpayers or married taxpayers filing separately
• $11,600 for married taxpayers filing jointly
• $8,500 for taxpayers filing as head of household

Personal Exemption for 2011:

The personal exemption amount is $3,700 (up from $3,650 in 2010).

Remember that there's a temporary repeal of the standard deduction and personal exemption income limit phaseout until 2012. This means that all taxpayers will receive the full deduction and exemption amounts. Give us a call if you have questions about this.

Financial Tips for May 2011

When to Review Your Life Insurance Coverage

It makes good financial sense to periodically examine your life insurance coverage to make sure the coverage is still sufficient. After all, life insurance is often a family's most important financial and estate planning tool.

With today's frequent changes in financial circumstances and goals, it's a good idea to re-examine your life insurance coverage on the occurrence of any of the following:

• Marriage or divorce;
• Birth or adoption, or acquiring a financial dependent such as a parent;
• Children leaving for college;
• Children "leaving the nest";
• Purchase or sale of a home;
• Serious illness;
• Substantial growth or depletion of assets;
• Retirement; and
• Start-up of a business.

Tip: In addition to the amount of coverage, you may need to make a change relating to beneficiaries, policy ownership, or type of coverage.

Consult with us if you think it might be time to adjust your life insurance coverage.

A Slip of the Lip May Bring on a Tax Audit

Many taxpayers have learned, to their dismay, that it generally isn't wise to talk carelessly about their taxes - especially about sensitive areas. Why? Because the wrong person overheard their careless talk and "turned informer," either for revenge or in the hope of an "informer's reward."

An informer's "tip" to the IRS will often trigger a tax audit. Even though the taxpayer has done nothing improper, he or she may have to suffer through the audit. Not only is this time-consuming, but it can also result in additional taxes due to the discovery of an innocent error on the return or the disallowance of a marginal deduction.

Tip: Most informers are disgruntled employees and former spouses or lovers.

Check Your Credit Report

Order a copy of your credit report from one of the major credit reporting agencies. Read the report carefully and report any discrepancies to the appropriate agencies. This not only ensures that the records are accurate, but also helps prevent others from obtaining credit in your name.

Review Budget vs. Actuals

Compare April income and expenditures with your budget. Make adjustments as appropriate to your May expenditures. Make sure you have invested your planned savings amount for April.

Make Withholding Adjustments

Based on the results of your prior year's tax return, make any necessary adjustments to your tax withholding by completing Form W-4 and giving it to your employer.

Tax Due Dates for May 2011

May 2	Employers - Social Security, Medicare, and withheld income tax. File Form 941 for the first quarter of 2011. Deposit any undeposited tax. (If your tax liability is less than $2,500, you can pay it in full with a timely filed return.) If you deposited the tax for the quarter in full and on time, you have until May 10 to file the return. Employers - Federal Unemployment Tax. Deposit the tax owed through March if more than $500.
May 10	Employers - Social Security, Medicare, and withheld income tax. File Form 941 for the first quarter of 2011. This due date applies only if you deposited the tax for the quarter in full and on time. Employees - who work for tips. If you received $20 or more in tips during April, report them to your employer. You can use Form 4070.
May 16	Employers - Nonpayroll withholding. If the monthly deposit rule applies, deposit the tax for payments in April. Employers - Social Security, Medicare, and withheld income tax. If the monthly deposit rule applies, deposit the tax for payments in April.

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