Recruiting a stellar nanny or caregiver can be time consuming and difficult. However, once you have found a candidate that you like and trust, paying household service providers may seem straightforward – after all, “cash is king” for many workers. Many busy household employers are happy to keep the hiring process simple and do not wish to complicate the employment process by researching laws regarding wage and hour laws, taxes, and other employment regulations. However, not setting up household workers’ wages, withholdings, and taxes accurately and compliantly can lead to excessive amounts of time and money put towards managing claims, lawsuits, and reputational repair.
In household environments (where employment relationships are often managed more informally than traditional workplaces), the decision to pay an employee compliantly is a choice many household employers face. However, this is becoming increasingly complicated, in part by newly imposed regulations that families with incomes of more than $400,000 are also facing the threat of increased attention from the Internal Revenue Service (IRS) as the federal government promises to investigate high earners and their assets in 2023 and beyond.
When you begin to consider the full scope of factors that can help protect you from employment liability, you may begin to wonder:
- How much should I pay my housekeeper – and what are some best practices?
- Should I pay my nanny via cash, check, or use a nanny payroll service?
- What are the IRS rules for paying a caregiver?
- Is paying a nanny “under the table” legal?
- Do I need a written agreement with my household employee?
Five common mistakes when paying household service providers
Regardless of the household’s income, the number of workers in the home, or how often they provide services, the mere exchange of work for money may make the household an employer in the United States – so it is best to ensure that the employment relationship is compliant and holds up to IRS scrutiny for years to come.
The Department of Labor (DOL), state labor boards, and the IRS all have overlapping – and sometimes conflicting – guidance on how to pay household employees. Unfortunately, these laws can be difficult to research and interpret alone, so it’s critical to stay well-informed (or enlist the help of an expert) in order to keep wage- and hour-related claims at bay. Ultimately, every time an employee is paid in a way that is not 100% above-board, new records of non-compliance are created and the employer is exposed to further liability.
Even in the most well-managed employment relationships – or in cases of employing family and friends – workers’ status as employees ultimately ensures that state and federal agencies are waiting to act as counsel on their behalf when, not if, an employment issue arises. Documentation is a great start, but will only protect employers so much if questions arise. The set of federal rules that dictate how workers in the United States must be paid, protected, and classified (often referred to as “wage and hour law”) is complex, and errs on the side of being employee-friendly.
Be sure to avoid these five common mistakes when setting up service providers’ payment terms to remain compliant and create safety nets for both the employer and employees.
1. Misclassifying a worker
Worker classification is one of the most misunderstood and contentious issues in American employment law. It’s common for workers and employers alike to perceive flexibility in classification, when in reality, there is none. After all, being a 1099 independent contractor requires much less paperwork than being a W-2 employee, so it’s often thought to be simpler and easier for everyone involved. Unfortunately, these issues are very black and white in the eyes of the law, and the consequences of misclassification can be quite costly.
You may have seen debates about independent contractor status in the news, as court cases involving Uber, Lyft, Doordash, Instacart, and other corporations have hit headlines. It’s easy to assume that the confusion plaguing these multi-million dollar companies couldn’t possibly translate to paying a single caregiver in a home, but those same laws are applied regardless of staff size.
As of 2023, the DOL is working on a new law that is more worker-friendly than ever and presumes that most workers are W-2 employees. A majority of states also have new laws stating that all workers are presumed to be employees unless explicitly proven otherwise, typically in writing and against a strict set of standards that must be applied in determining to prove independent contractor status. This is a significant pivot from prior widely-adopted labor standards, which typically did not address contractor status.
As intimidating as it may be, it is critical to understand the federal and state requirements around worker classification in the area work is being performed before proceeding with a new hire. Short-term, categorizing a worker as a contractor (when they should be a W-2 employee) may “save” on upfront labor costs. However, employers who are found guilty of intentionally misclassifying a worker will find themselves paying back taxes and assorted damages.
Those costs can rack up quickly and often equate to 2-3x the cost of the issue at hand, especially with punitive damages factored in. A misclassified worker who is paid $50,000/year with a typical 25% income tax rate may leave the employer on the hook for over $35,000 in overall costs – before factoring in court fees and the cost of securing legal representation.
Even if the ease of providing a nanny or other type of household employee a 1099 tax form seems worth the potential risk, it is important to understand how this choice affects the safety of both the employer and the employee:
- Independent contractors are supposed to carry their own workers’ compensation insurance, whereas W-2 employees should, in most states, be covered by their employers’ insurance. One of the first questions that most hospitals or clinics ask a patient is whether or not their visit is job-related. What will households do if their misclassified worker gets hurt while working in the home, and the employer lacks proper coverage?
- Employees get access to unemployment insurance because their employers have paid employee and employer payroll taxes to the state. Independent contractors typically do not get this benefit, since they do not have the same taxation requirements. What will household employers do if, years after the worker leaves the home, they apply for unemployment and it is found that misclassification resulted in denial of state benefits?
- Many institutions or businesses, such as mortgage lenders and car dealerships, are beholden to very strict income verification laws. This means that customers cannot gain access to critical services without a written pay stub or verification of employment. What will household employers do if the worker is denied a loan because their employer cannot supply proof of a compliant employment history?
2. Paying cash
The guidance here is clear-cut: cash simply does not work for the stringent recordkeeping practices required by the IRS and the DOL. Even if your nanny requests to be paid in cash or “under the table,” you are inadvertently introducing liability for both parties by agreeing to pay off the books.
Some common pay setup mistakes that come along with paying cash are:
- Not reporting wages to the IRS
- Not withholding correct payroll taxes for the employee, which denies them access to state and federal programs such as unemployment, paid family and medical leave, disability leave, Social Security or Medicare, etc.
- Not registering as an employer
- Not providing pay stubs or wage statements with required information on them
- Not paying state and local employment taxes correctly
Even if payroll taxes are calculated correctly or a nanny payroll calculator is used, the unfortunate reality is that without the clear records established through state tax remittances, IRS filings, and detailed pay stubs, the cards are stacked against the employer if an agency should ever choose to investigate those payroll practices. Bad recordkeeping can be just as damaging as no recordkeeping at all, and simple errors can add up quickly when punitive damages and back taxes are taken into account.
Did you know?
Forty one states require some level of paper documentation to be given to an employee each and every time they are paid, and the Fair Labor Standards Act (FLSA) requires that all payroll records be retained for at least five years
3. Paying a salary instead of by the hour
On the surface, paying a salary sounds both simple and legal: workers, as well as their managers, get to enjoy the stability that predictable payments bring to their budget. For roles like nannies and caregivers, where schedules can fluctuate significantly based on the household’s needs, this is an especially appealing option. Home care and household employee payroll services will even go so far as to encourage it – the ease of paying a salary seems clear all around.
Unfortunately, the compensation laws set forth by the FLSA are not so easy. Determining who is legally eligible for a salary, versus who must be paid hourly and be given the chance to earn overtime, requires a comprehensive analysis of the employee’s job duties before hiring them.
Although the precise nature of the employee’s duties may vary, and exemption status is also determined by the amount they are paid each week, a general rule of thumb is:
- Exempt workers: Can be paid a salary, are not required to track hours on timecards, and cannot earn overtime. For example:
- Chefs who are supervising 2 or more full-time employees, or have been to a 4-year culinary institution
- Household managers who supervise 2 or more full-time employees or have primarily administrative duties that relate to the operation of a business
- White-collar workers who have significant discretion or control over their duties and can exercise independent judgment at work
- Non-Exempt workers: Must be paid hourly, track their hours on timecards, and be paid overtime if they work it. For example:
- Nearly all “manual” jobs, such as caregiving, nannying, housekeeping, driving, cooking, and landscaping
- Employees in assistant roles, who have their work assigned to them or cannot exercise significant control over their duties and responsibilities
Paying a salary when you should be paying hourly opens you up to significant employment liability. Even if the employee is paid the correct amount and never works overtime, not using timecards means that the employer has no proof of calculating potential overtime wages correctly. This turns any wage and hour claim into a “he said, she said” situation and can become unnecessarily complex and costly.
4. Not calculating overtime correctly
As touched on above, overtime is another “black and white” part of wage and hour law that many household employers – and even outsourced human resources and payroll companies – inadvertently get wrong.
Many states have unique overtime laws that go above and beyond the FLSA’s federal definition of overtime as any work over 40 hours in a workweek, including:
- Overtime (1.5x your regular hourly rate) if an employee works more than 8 hours in a day
- Overtime if an employee works more than 12 hours in a shift
- Double time (2x your regular hourly rate) if an employee works more than 12 hours in a shift
These overtime laws are even more complex when special considerations are taken into account, such as travel (for example, employers must pay overtime according to the laws of where the work is being performed) and employee type, since there are unique laws for domestic employees. A common mistake for many household employers is believing that they are exempt from paying overtime because of their status as household employers, but those special carve outs are usually only available in certain areas, to certain types of workers, and to certain people who have actually created a separate business entity and registered with the IRS and the state as household employers.
5. Not paying the right minimum wage
As of writing this article, more than 45 cities, 12 counties, and 33 states have minimum wage laws higher than the federal minimum of $7.25. If a household employer does not know what the current minimum wage is based on their ZIP code and the employee’s industry, they will want to ensure that they audit their pay practices for compliance immediately. Because determining someone’s hourly wage is such a simple formula, it is equally simple to prove wrongdoing – even in good-faith, casual employment relationships.
This also goes for paying a “day rate” or per diem to household employees, which is a convenient and common, yet very dangerous, practice for nannies and caregivers alike. If an employee is being paid a set amount per shift and not dividing their total payment by the number of hours they actually work in that shift, how can the employer prove they are paying employees correctly at all?
Ensure your pay setup is compliant now to avoid consequences later
Wage and hour best practices are tricky, and as individual localities continue to take employment law into their own hands, they will only grow more complicated. Luckily, creating and maintaining a compliant pay setup now will not only help household employers navigate the complexities of employment in the future, but will also help protect both the employer and employee. Working with an expert in the household employment industry can not only help reduce the burden of paperwork and compliance that most domestic employers face, but also help avoid any headaches down the line. TEAM’s all-in-one payroll and HR solution is custom-built to support individuals and families with household staff, allowing households to focus on what matters most. Contact us to learn more about how we can help.