LGH Consulting, Inc.

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You may owe “nanny tax” even if you don’t have a nanny

Have you heard of the “nanny tax?” Even if you don’t employ a nanny, it may apply to you. Hiring a house cleaner, gardener or other household employee (who isn’t an independent contractor) may make you liable for federal income and other taxes. You may also have state tax obligations.

If you employ a household worker, you aren’t required to withhold federal income taxes from pay. But you can choose to withhold if the worker requests it. In that case, ask the worker to fill out a Form W-4. However, you may be required to withhold Social Security and Medicare (FICA) taxes and to pay federal unemployment (FUTA) tax.

2021 and 2022 thresholds

In 2021, you must withhold and pay FICA taxes if your household worker earns cash wages of $2,300 or more (excluding the value of food and lodging). The Social Security Administration recently announced that this amount would increase to $2,400 in 2022. If you reach the threshold, all the wages (not just the excess) are subject to FICA.

However, if a nanny is under age 18 and childcare isn’t his or her principal occupation, you don’t have to withhold FICA taxes. So, if you have a part-time student babysitter, there’s no FICA tax liability.

Both an employer and a household worker may have FICA tax obligations. As an employer, you’re responsible for withholding your worker’s FICA share. In addition, you must pay a matching amount. FICA tax is divided between Social Security and Medicare. The Social Security tax rate is 6.2% for the employer and 6.2% for the worker (12.4% total). Medicare tax is 1.45% each for the employer and the worker (2.9% total).

If you want, you can pay your worker’s share of Social Security and Medicare taxes. If you do, your payments aren’t counted as additional cash wages for Social Security and Medicare purposes. However, your payments are treated as additional income to the worker for federal tax purposes, so you must include them as wages on the W-2 form that you must provide.

You also must pay FUTA tax if you pay $1,000 or more in cash wages (excluding food and lodging) to your worker in any calendar quarter. FUTA tax applies to the first $7,000 of wages paid and is only paid by the employer.

Paperwork and payments 

You pay household worker obligations by increasing your quarterly estimated tax payments or increasing withholding from wages, rather than making an annual lump-sum payment.

As an employer of a household worker, you don’t have to file employment tax returns, even if you’re required to withhold or pay tax (unless you own your own business). Instead, employment taxes are reported on your tax return on Schedule H.

When you report the taxes on your return, include your employer identification number (not the same as your Social Security number). You must file Form SS-4 to get one.

However, if you own a business as a sole proprietor, you include the taxes for a household worker on the FUTA and FICA forms (940 and 941) that you file for the business. And you use your sole proprietorship EIN to report the taxes.

Recordkeeping is important 

Keep related tax records for at least four years from the later of the due date of the return or the date the tax was paid. Records should include the worker’s name, address, Social Security number, employment dates, dates and amount of wages paid and taxes withheld, and copies of forms filed.

Contact us for assistance or questions about how to comply with these requirements.

© 2021

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Hiring your minor children this summer? Reap tax and nontax benefits

If you’re a business owner and you hire your children this summer, you can obtain tax breaks and other nontax benefits. The kids can gain on-the-job experience, spend time with you, save for college and learn how to manage money. And you may be able to:

  • Shift your high-taxed income into tax-free or low-taxed income,
  • Realize payroll tax savings (depending on the child’s age and how your business is organized), and
  • Enable retirement plan contributions for the children.

A legitimate job

If you hire your child, you get a business tax deduction for employee wage expenses. In turn, the deduction reduces your federal income tax bill, your self-employment tax bill (if applicable), and your state income tax bill (if applicable). However, in order for your business to deduct the wages as a business expense, the work performed by the child must be legitimate and the child’s salary must be reasonable.

For example, let’s say you operate as a sole proprietor and you’re in the 37% tax bracket. You hire your 16-year-old daughter to help with office work on a full-time basis during the summer and part-time into the fall. Your daughter earns $10,000 during 2021 and doesn’t have any other earnings.

You save $3,700 (37% of $10,000) in income taxes at no tax cost to your daughter, who can use her 2021 $12,550 standard deduction to completely shelter her earnings.

Your family’s taxes are cut even if your daughter’s earnings exceed her standard deduction. Why? The unsheltered earnings will be taxed to the daughter beginning at a rate of 10%, instead of being taxed at your higher rate.

How payroll taxes might be saved

If your business isn’t incorporated, your child’s wages are exempt from Social Security, Medicare, and FUTA taxes if certain conditions are met. Your child must be under age 18 for this to apply (or under age 21 in the case of the FUTA tax exemption). Contact us for how this works.

Be aware that there’s no FICA or FUTA exemption for employing a child if your business is incorporated or a partnership that includes nonparent partners. And payments for the services of your child are subject to income tax withholding, regardless of age, no matter what type of entity you operate.

Begin saving for retirement

Your business also may be able to provide your child with retirement benefits, depending on the type of plan you have and how it defines qualifying employees. And because your child has earnings from his or her job, he can contribute to a traditional IRA or Roth IRA and begin to build a nest egg. For the 2021 tax year, a working child can contribute the lesser of his or her earned income, or $6,000, to an IRA or a Roth.

Keep accurate records 

As you can see, hiring your child can be a tax-smart idea. Be sure to keep the same records as you would for other employees to substantiate the hours worked and duties performed (such as timesheets and job descriptions). Issue your child a Form W-2. Contact us if you have questions about how these rules apply to your situation.

© 2021

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Help ensure the IRS doesn’t reclassify independent contractors as employees

Many businesses use independent contractors to help keep their costs down. If you’re among them, make sure that these workers are properly classified for federal tax purposes. If the IRS reclassifies them as employees, it can be a costly error.

It can be complex to determine whether a worker is an independent contractor or an employee for federal income and employment tax purposes. If a worker is an employee, your company must withhold federal income and payroll taxes, pay the employer’s share of FICA taxes on the wages, plus FUTA tax. A business may also provide the worker with fringe benefits if it makes them available to other employees. In addition, there may be state tax obligations.

On the other hand, if a worker is an independent contractor, these obligations don’t apply. In that case, the business simply sends the contractor a Form 1099-NEC for the year showing the amount paid (if it’s $600 or more).

What are the factors the IRS considers?

Who is an “employee?” Unfortunately, there’s no uniform definition of the term.

The IRS and courts have generally ruled that individuals are employees if the organization they work for has the right to control and direct them in the jobs they’re performing. Otherwise, the individuals are generally independent contractors. But other factors are also taken into account including who provides tools and who pays expenses.

Some employers that have misclassified workers as independent contractors may get some relief from employment tax liabilities under Section 530. This protection generally applies only if an employer meets certain requirements. For example, the employer must file all federal returns consistent with its treatment of a worker as a contractor and it must treat all similarly situated workers as contractors.

Note: Section 530 doesn’t apply to certain types of workers.

Should you ask the IRS to decide?

Be aware that you can ask the IRS (on Form SS-8) to rule on whether a worker is an independent contractor or employee. However, be aware that the IRS has a history of classifying workers as employees rather than independent contractors.

Businesses should consult with us before filing Form SS-8 because it may alert the IRS that your business has worker classification issues — and it may unintentionally trigger an employment tax audit.

It may be better to properly treat a worker as an independent contractor so that the relationship complies with the tax rules.

Workers who want an official determination of their status can also file Form SS-8. Disgruntled independent contractors may do so because they feel entitled to employee benefits and want to eliminate self-employment tax liabilities.

If a worker files Form SS-8, the IRS will notify the business with a letter. It identifies the worker and includes a blank Form SS-8. The business is asked to complete and return the form to the IRS, which will render a classification decision.

These are the basic tax rules. In addition, the U.S. Labor Department has recently withdrawn a non-tax rule introduced under the Trump administration that would make it easier for businesses to classify workers as independent contractors. Contact us if you’d like to discuss how to classify workers at your business. We can help make sure that your workers are properly classified.

© 2021

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Tax advantages of hiring your child at your small business

As a business owner, you should be aware that you can save family income and payroll taxes by putting your child on the payroll.

Here are some considerations.

Shifting business earnings

You can turn some of your high-taxed income into tax-free or low-taxed income by shifting some business earnings to a child as wages for services performed. In order for your business to deduct the wages as a business expense, the work done by the child must be legitimate and the child’s salary must be reasonable.

For example, suppose you’re a sole proprietor in the 37% tax bracket. You hire your 16-year-old son to help with office work full-time in the summer and part-time in the fall. He earns $10,000 during the year (and doesn’t have other earnings). You can save $3,700 (37% of $10,000) in income taxes at no tax cost to your son, who can use his $12,550 standard deduction for 2021 to shelter his earnings.

Family taxes are cut even if your son’s earnings exceed his standard deduction. That’s because the unsheltered earnings will be taxed to him beginning at a 10% rate, instead of being taxed at your higher rate.

Income tax withholding

Your business likely will have to withhold federal income taxes on your child’s wages. Usually, an employee can claim exempt status if he or she had no federal income tax liability for last year and expects to have none this year.

However, exemption from withholding can’t be claimed if: 1) the employee’s income exceeds $1,100 for 2021 (and includes more than $350 of unearned income), and 2) the employee can be claimed as a dependent on someone else’s return.

Keep in mind that your child probably will get a refund for part or all of the withheld tax when filing a return for the year.

Social Security tax savings 

If your business isn’t incorporated, you can also save some Social Security tax by shifting some of your earnings to your child. That’s because services performed by a child under age 18 while employed by a parent aren’t considered employment for FICA tax purposes.

A similar but more liberal exemption applies for FUTA (unemployment) tax, which exempts earnings paid to a child under age 21 employed by a parent. The FICA and FUTA exemptions also apply if a child is employed by a partnership consisting only of his or her parents.

Note: There’s no FICA or FUTA exemption for employing a child if your business is incorporated or is a partnership that includes non-parent partners. However, there’s no extra cost to your business if you’re paying a child for work you’d pay someone else to do.

Retirement benefits

Your business also may be able to provide your child with retirement savings, depending on your plan and how it defines qualifying employees. For example, if you have a SEP plan, a contribution can be made for the child up to 25% of his or her earnings (not to exceed $58,000 for 2021).

Contact us if you have any questions about these rules in your situation. Keep in mind that some of the rules about employing children may change from year to year and may require your income-shifting strategies to change too.

© 2021

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2021 Q1 tax calendar: Key deadlines for businesses and other employers

Here are some of the key tax-related deadlines affecting businesses and other employers during the first quarter of 2021. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.

January 15

  • Pay the final installment of the 2020 estimated tax.
  • Farmers and fishermen: Pay estimated tax for 2020.

February 1 (The usual deadline of January 31 is a Sunday)

  • File 2020 Forms W-2, “Wage and Tax Statement,” with the Social Security Administration and provide copies to your employees.
  • Provide copies of 2020 Forms 1099-MISC, “Miscellaneous Income,” to recipients of income from your business where required.
  • File 2020 Forms 1099-MISC reporting nonemployee compensation payments in Box 7 with the IRS.
  • File Form 940, “Employer’s Annual Federal Unemployment (FUTA) Tax Return,” for 2020. If your undeposited tax is $500 or less, you can either pay it with your return or deposit it. If it’s more than $500, you must deposit it. However, if you deposited the tax for the year in full and on time, you have until February 10 to file the return.
  • File Form 941, “Employer’s Quarterly Federal Tax Return,” to report Medicare, Social Security, and income taxes withheld in the fourth quarter of 2020. 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 February 10 to file the return. (Employers that have an estimated annual employment tax liability of $1,000 or less may be eligible to file Form 944, “Employer’s Annual Federal Tax Return.”)
  • File Form 945, “Annual Return of Withheld Federal Income Tax,” for 2020 to report income tax withheld on all nonpayroll items, including backup withholding and withholding on accounts such as pensions, annuities, and IRAs. 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 year in full and on time, you have until February 10 to file the return.

March 1 (The usual deadline of February 28 is a Sunday)

  • File 2020 Forms 1099-MISC with the IRS if: 1) they’re not required to be filed earlier and 2) you’re filing paper copies. (Otherwise, the filing deadline is March 31.)

March 16

  • If a calendar-year partnership or S corporation, file or extend your 2020 tax return and pay any tax due. If the return isn’t extended, this is also the last day to make 2020 contributions to pension and profit-sharing plans.

© 2020

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More parents may owe “nanny tax” this year, due to COVID-19

In the COVID-19 era, many parents are hiring nannies and babysitters because their daycare centers and summer camps have closed. This may result in federal “nanny tax” obligations.

Keep in mind that the nanny tax may apply to all household workers, including housekeepers, babysitters, gardeners or others who aren’t independent contractors.

If you employ someone who’s subject to the nanny tax, you aren’t required to withhold federal income taxes from the individual’s pay. You only must withhold if the worker asks you to and you agree. (In that case, ask the nanny to fill out a Form W-4.) However, you may have other withholding and payment obligations.

Withholding FICA and FUTA

You must withhold and pay Social Security and Medicare taxes (FICA) if your nanny earns cash wages of $2,200 or more (excluding food and lodging) during 2020. If you reach the threshold, all of the wages (not just the excess) are subject to FICA.

However, if your nanny is under 18 and childcare isn’t his or her principal occupation, you don’t have to withhold FICA taxes. Therefore, if your nanny is really a student/part-time babysitter, there’s no FICA tax liability.

Both employers and household workers have an obligation to pay FICA taxes. Employers are responsible for withholding the worker’s share of FICA and must pay a matching employer amount. FICA tax is divided between Social Security and Medicare. Social Security tax is 6.2% for both the employer and the worker (12.4% total). Medicare tax is 1.45% each for both the employer and the worker (2.9% total).

If you prefer, you can pay your nanny’s share of Social Security and Medicare taxes, instead of withholding it from pay.

Note: It’s unclear how these taxes will be affected by the executive order that President Trump signed on August 8, which allows payroll taxes to be deferred from September 1 through December 31, 2020.

You also must pay federal unemployment (FUTA) tax if you pay $1,000 or more in cash wages (excluding food and lodging) to your worker in any calendar quarter of this year or last year. FUTA tax applies to the first $7,000 of wages. The maximum FUTA tax rate is 6%, but credits reduce it to 0.6% in most cases. FUTA tax is paid only by the employer.

Reporting and paying

You pay nanny tax by increasing your quarterly estimated tax payments or increasing withholding from your wages — rather than making an annual lump-sum payment.

You don’t have to file any employment tax returns, even if you’re required to withhold or pay tax (unless you own a business, see below). Instead, you report employment taxes on Schedule H of your tax return.

On your return, you include your employer identification number (EIN) when reporting employment taxes. The EIN isn’t the same as your Social Security number. If you need an EIN, you must file Form SS-4.

However, if you own a business as a sole proprietor, you must include the taxes for your nanny on the FICA and FUTA forms (940 and 941) that you file for your business. And you use the EIN from your sole proprietorship to report the taxes. You also must provide your nanny with a Form W-2.

Recordkeeping

Maintain careful tax records for each household employee. Keep them for at least four years from the later of the due date of the return or the date the tax was paid. Records include: employee name, address, Social Security number; employment dates; wages paid; withheld FICA or income taxes; FICA taxes paid by you for your worker; and copies of forms filed.

Contact us for help or with questions about how to comply with these requirements.

© 2020

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The “nanny tax” must be paid for more than just nannies

You may have heard of the “nanny tax.” But even if you don’t employ a nanny, it may apply to you. Hiring a housekeeper, gardener or other household employees (who isn’t an independent contractor) may make you liable for federal income and other taxes. You may also have state tax obligations.

If you employ a household worker, you aren’t required to withhold federal income taxes from pay. But you may choose to withhold if the worker requests it. In that case, ask the worker to fill out a Form W-4. However, you may be required to withhold Social Security and Medicare (FICA) taxes and to pay federal unemployment (FUTA) tax.

FICA and FUTA tax

In 2019, you must withhold and pay FICA taxes if your household worker earns cash wages of $2,100 or more (excluding the value of food and lodging). If you reach the threshold, all the wages (not just the excess) are subject to FICA.

However, if a nanny is under age 18 and childcare isn’t his or her principal occupation, you don’t have to withhold FICA taxes. So, if you have a part-time babysitter who is a student, there’s no FICA tax liability.

Both an employer and a household worker may have FICA tax obligations. As an employer, you’re responsible for withholding your worker’s FICA share. In addition, you must pay a matching amount. FICA tax is divided between Social Security and Medicare. The Social Security tax rate is 6.2% for the employer and 6.2% for the worker (12.4% total). Medicare tax is 1.45% each for both the employer and the worker (2.9% total).

If you want, you can pay your worker’s share of Social Security and Medicare taxes. If you do, your payments aren’t counted as additional cash wages for Social Security and Medicare purposes. However, your payments are treated as additional income to the worker for federal tax purposes, so you must include them as wages on the W-2 form that you must provide.

You also must pay FUTA tax if you pay $1,000 or more in cash wages (excluding food and lodging) to your worker in any calendar quarter. FUTA tax applies to the first $7,000 of wages paid and is only paid by the employer.

Reporting and paying

You pay household worker obligations by increasing your quarterly estimated tax payments or increasing withholding from wages, rather than making an annual lump-sum payment.

As a household worker-employer, you don’t have to file employment tax returns, even if you’re required to withhold or pay tax (unless you own your own business). Instead, employment taxes are reported on your tax return on Schedule H.

When you report the taxes on your return, you include your employer identification number (not the same as your Social Security number). You must file Form SS-4 to get one.

However, if you own a business as a sole proprietor, you include the taxes for a household worker on the FUTA and FICA forms (940 and 941) that you file for your business. And you use your sole proprietorship EIN to report the taxes.

Keep careful records

Keep related tax records for at least four years from the later of the due date of the return or the date the tax was paid. Records should include the worker’s name, address, Social Security number, employment dates, dates and amount of wages paid and taxes withheld, and copies of forms filed.

Contact us for assistance or questions about how to comply with these employment tax requirements.

© 2019