Because of the pandemic, many brick and mortar schools have shifted to remote instruction. However, for a variety of reasons, remote learning may not be a suitable option for every family. To address the particular needs and circumstances of each family, such as health concerns, some have turned to homeschooling pods (small groups of children sharing a learning space led by a pod instructor) or have hired nannies to care for younger children. Parents hiring pod instructors, nannies, and similar household workers may be unfamiliar with tax filing and withholding requirements. As a result, they may find themselves with unexpected tax liabilities or penalties. It is important to understand the tax consequences of hiring a household worker, including whether a worker is treated as an “employee” or an “independent contractor” for both federal and state reporting.
Employee or independent contractor?
For tax purposes, parents need to determine whether a pod instructor or nanny is an employee or an independent contractor. Parents should consider the degree of control they exercise over the pod instructor or nanny. To assist in making this determination, the IRS issued Rev. Rul. 87-41, which lists 20 factors for taxpayers to consider. To simplify the analysis, the IRS has grouped these factors into three categories (see IRS Publication 15-A, Employer’s Supplemental Tax Guide):
- behavioral control;
- financial control; and
- the relationship of the parties.
In summary, a worker is considered an employee if the parent retains the right to control what work is done and the way it is done. For example, an employee may be directed to work on a certain schedule and specifically instructed in how to perform his or her work. By contrast, an independent contractor retains substantial control over the manner and means through which a service or product is delivered.
When applying the IRS factors to a nanny or a pod instructor based upon the specific facts, a nanny most often is an employee, whereas a pod instructor is more likely to be an independent contractor. This is because parents typically establish specific constraints or instructions that the nanny operates within, such as scheduling, day-to-day activities, and disciplinary methods. Meanwhile, pod instructors generally retain instructional control over the learning environment in terms of what is being taught and how. However, results may vary depending on the circumstances. For example, parents cannot rely on this rule of thumb if their nannies have more autonomy or pod instructors are micromanaged. (And it is worth noting that a tutor hired to provide supplemental instruction in a subject like algebra or chemistry would generally be treated as an independent contractor.)
Parents should examine who sets the schedule, who provides the educational and childcare materials, and how specifically they manage the details of their nanny’s or pod instructor’s work. The more control a parent exerts over the arrangement, the more likely the worker is an employee. After considering and applying all the factors to the situation, parents will need to decide whether the nanny or pod instructor should be classified as an employee or an independent contractor. Each parent’s situation may be different. Note that if a pod instructor or nanny provides their services through a company, the company is usually considered the employer, not the parents.
Like parents, pod instructors have an interest in how they are classified, as their classification will generate differing tax consequences for themselves. State taxing authorities may have specific rules that should be considered as well. Parents and pod instructors who want more certainty can seek assistance from the IRS in determining worker classification by completing and submitting Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. As previously reported by the National Taxpayer Advocate, this process can be quite long and burdensome. Nevertheless, receiving an official decision, although delayed, may be helpful in resolving disputes between parents and pod instructors.
Tax consequences for the parents, nanny, or pod instructor?
It is critical for taxpayers to carefully consider their particular facts and circumstances. There is no one-size-fits-all answer.
- If parents deem the nanny or pod instructor to be an independent contractor, they should keep careful records and receipts of all amounts paid. Independent contractors are responsible for paying all self-employment taxes and properly filing their returns. Parents may refer independent contractors to the IRS Self-Employed Individuals Tax Center for more information on how to do this.
- However, if parents deem the nanny or pod instructor to be an employee, they will need to consider how to file the necessary forms with the IRS and withhold and pay the required taxes.
- Here are a few key things to do immediately:
- First, parents should apply for an Employer Identification Number (EIN) , which should be included on all future filings with the IRS.
- Second, parents will need to determine whether they meet the threshold requirement to pay employment taxes.
- For 2020, if at least $2,200 in cash wages is paid to a household employee, they will need to pay Social Security and Medicare taxes.
- For any calendar quarter in 2019 or 2020, if at least $1,000 in cash wages is paid to a household employee, they will need to pay federal unemployment taxes.
- Parents should also check with their state of residence regarding requirements and procedures to pay state unemployment tax.
- Next, parents will need to discuss whether they, as the employer, will withhold and pay the taxes, or whether the employee will pay the taxes. If the parents will withhold, the employee will need to submit a Form W-4, Employees Withholding Certificate, to the employer.
- In general, payroll taxes are calculated as 15.3 percent of pay, with 7.65 percent paid by the employer and 7.65 percent withheld by the employer from the employee’s wages.
- Withheld federal income taxes can be calculated using a completed Form W-4.
- As an aside, parents should also check state law to determine whether they are required to obtain worker’s compensation insurance through a private carrier in case an employee is injured while working.
- Once the tax year ends:
- Parents will need to file a Form W-2, Wage and Tax Statement, with the IRS and a Form W-3, Transmittal of Wage and Tax Statements, with the Social Security Administration, and give the Form W-2 to the employee by January 31.
- During the tax filing season, parents will need to complete and file a Schedule H, Household Employment Taxes, with their own returns, which will be used to calculate the household employment taxes due to be paid by April 15.
- For more detailed instruction, parents can refer to Internal Revenue Manual (IRM) 22.214.171.124.5, Household Employment Taxes, and IRS Publication 926, Household Employer’s Tax Guide.
As we all navigate the novel circumstances brought about by the COVID-19 pandemic, taxes may not be a parent’s first concern. However, parents need to be mindful of the federal (and state) tax consequences of their childcare or remote learning environments and should consult with a tax advisor as necessary. Families should keep careful records and receipts and consider the use of an employer Dependent Care Flexible Spending Account (FSA) or Child or Dependent Care Tax Credit eligibility. Parents hiring pod instructors or nannies should be informed about the tax consequences and should be equipped to comply with all tax requirements.
For more information, see IRS Publication 926, Household Employer’s Tax Guide, and other sources of information cited in this blog.