Employee or Independent Contractor?

If you decide to hire and individual -- not a company or agency -- to work in your home, the question arises as to whether the worker is considered your employee or an independent contractor. The answer will make a big difference in which tax laws and other rules you have to follow. Generally speaking, you have more responsibility for an employee than you do for an independent contractor. To complicate matters, there's no one definition of who qualifies as an "employee". Different government bodies have different definitions, which you'll have to familiarize yourself with in order to follow the appropriate laws. For example:

  • The IRS and state tax agencies definition of an employee determines whether you're required to pay and withhold taxes from your worker's paychecks.
  • State and federal labor departments' definitions of who is an employee is key in determining whether you employees are entitled to certain protections, such as minimum wage and overtime provisions, to which independent contractors are not entitled.
  • State unemployment insurance or workers' compensation boards definitions of "employee" matter because someday, the worker may file for unemployment or be injured on the job, and you'll need to have insurance to cover these situations.

In general, the more control you exercise over the worker, the more likely it is that you'll be considered the "employer" by any of these agencies. If you hire the person to work certain hours, direct what the person does and how it's done, and the person works only for you, you're probably an employer. For example, a nanny you hire to watch your children each day will more than likely be considered an employee. On the other hand, if the person offers services to the general public, furnishes the needed equipment or tools, and controls how and when work is done, the person is more likely an independent contractor. Gardeners or trained professionals like electricians are commonly independent contractors. (To learn more about who qualifies as an employee, read Nolo's article Independent Contractor or Employee: How Government Agencies Make the Call.)

Your Tax Responsibilities

If a worker is an independent contractor, your federal tax responsibilities are few. In fact, you don't even need to fill out the IRS form (1099-MISC) usually required when hiring independent contractors, because an exception excludes household workers. But it's a different story if you are the worker's employer. Here are some of your responsibilities: Get an employer identification number. For starters, you'll need to let the IRS know you're an employer and get an employer identification number (EIN), which you can do via the IRS website at www.irs.gov. Check immigration documents. Also, you'll have to verify that the individual is legally authorized to work in the United States by having the worker fill out U.S. Citizenship and Immigration Services (USCIS) Form I-9, Employment Eligibility Verification and present documentary proof of having the right to work. You won't have to submit the I-9 to anyone, but you will have to keep it on hand in case you're audited or investigated. Pay taxes. If you pay a worker $1,700 per year or more in 2010 (the amount changes each year), you and the employee must each pay 7.65% of the employee's wages in Social Security and Medicare taxes. In addition to your half, you're responsible for withholding the employee's share of these taxes. And you'll have to check with your state tax agency to find out its withholding requirements. If you pay the employee $1,000 or more in any calendar quarter (any three-month period), you'll also have to pay federal unemployment (FUTA) taxes. The rate varies from state to state, but is usually 0.8% of the first $7,000 of annual wages paid to an employee. Also, you'll have to file IRS Form W-2 at the end of the year. Some people choose to hire a payroll service to handle these tasks.

Your Insurance Responsibilities

What happens if your employee is injured on the job? Usually, employers are responsible for paying for workplace injuries, and state law requires employers to have workers' compensation insurance to cover them. Whether you'll need it or not depends on the state you're in -- some states exclude domestic employees entirely, while others limit it to employees who work a certain amount or to employers of a minimum size. (The U.S. Department of Labor, at www.dol.gov, has a table listing each state's rules.) If you're required to purchase workers' compensation insurance, you may be able to obtain the coverage through your homeowners' insurance policy. Though coverage for workers is generally excluded, you can potentially buy a rider or endorsement, depending in part on your state's laws. Also, you'll probably have to pay for state unemployment insurance for your domestic worker. This provides income replacement and other work placement services to the worker if you end the employment relationship and the person is unemployed. The cost of this insurance varies by state.

Paying Your Employees

If you hire a domestic employee, you will have to comply with state and federal laws regarding paying that employee. For example, you must pay the employee at least the minimum wage in your state. (As a practical matter, you may have to pay much more than the minimum wage, because it may be hard to find someone willing to work for any less.) You may also have to pay overtime, though federal law doesn't require it for a household employee who lives in your home or for caregivers. (To learn more about the rules of overtime pay, read Nolo's article Overtime Pay.)