As household employment specialists, we regularly have families come to us after attempting to put their nanny -- or other household employee -- on their company's payroll. While it may seem like an easy and logical way to handle a domestic worker's payroll, it typically results in expensive, time-consuming problems.
Business owners who have household workers need to keep their household and business payrolls separate.
The reason? Businesses are allowed to take tax deductions on their payroll expense. But the IRS requires that everyone on the payroll be a "direct contributor to the success of the business" and they've ruled that nannies and other domestic workers do not pass the direct contributor test. As a result, putting a household employee on the company books can result in the company taking an illegal tax deduction.
There are also employment tax filing issues. Generally, business enterprises are not allowed to include household employment activity on their business tax returns. The only business categories that are allowed to marry their household and business employment tax filings are Sole Proprietorships and For-Profit Farms. (Note: Even though they're given some latitude on the filing process, Sole Proprietorships and For-Profit Farms are still subject to the illegal tax deduction danger stated above).
Finally, there are issues with group benefit plans. We recently saw a case where a family put their nanny on the company health insurance plan. The nanny was later diagnosed with cancer and had medical bills in excess of $100,000. When the health insurance provider learned that she was a personal employee of the family, they denied the claim because she was not a direct contributor to the success of the company and, therefore, was not covered by the group policy. The company was forced to cover those medical expenses.
Instead of mixing business and personal payroll and tax filing processes, families with household employees should follow the household employment tax process, which has different foms, different processes and different deadlines (not to mention different labor laws in many cases). Reference IRS Publication 926. When handled properly, the family can take tax breaks on dependent care expenses through their personal income tax process.
The Bottom Line: Failing to keep the household and business payroll separate can result in the need to amend both corporate and personal tax returns and pay penalty and interest assessments. Additionally, it can expose the company assets if there's ever legal action from a disgruntled former household employee.
Tom Breedlove is a partner at Breedlove & Associates, the nation's leading provider of household employment payroll, tax and HR services. Since 1992, their comprehensive service has eliminated all the work, worry and risk for busy families across the U.S.
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