Each Wednesday through April 21, baltimoresun.com's tax experts will answer your questions this tax-filing season.
Our experts are Jim Dupree of the Maryland office of the Internal Revenue Service in Baltimore and, this week, Nicole M. Harrell, head of her own accounting firm in Baltimore.
To be included next week, please use the form at the right side of this page to submit your questions.
What is the proper tax treatment for a domestic employee?
I have someone close to me (the employee) who is being paid by a close friend (the employer) to live in the employer's house as her caregiver. This arrangement began in March 2003 as a verbal agreement. The employee receives $375 a week, paid by check with no deduction or payment of employee payroll taxes.
The employee works and lives in the employer's house Monday through Friday, sleeping overnight through Thursday. Duties include preparing meals, housekeeping, accompanying the employer on doctor's appointments and other tasks.
The parties are close friends. Both are over 65 years old and have Social Security income.
The employee's pay of $375 a week, or $75 per day, was based on it being the maximum amount the employer may receive in reimbursement through a long-term disability insurance policy. No Form 1099s have been issued, nor has the insurer sought the employee's Social Security number.
The employee recalls being told by the employer that taxes were not due on the wages because the employee's salary was being reimbursed as medical expenses under an insurance policy.
Is this considered a domestic employee-employer relationship for tax purposes? Who is responsible for paying taxes in this relationship, and what impact might it have on the employee's Social Security benefits?
Dupree: In any household employee-employer relationship, the employer must file a W-2 form for each household employee earning $1,400 or more a year.
The employer also may be liable for federal unemployment taxes, if they paid wages of $1,000 or more in any quarter of the current or preceding calendar year, as well as Social Security, Medicare and federal income tax withholdings. These taxes are paid by the employer through Form 1040 Schedule H.
Usually, when payments are issued directly from a long-term disability insurance policy, an IRS Form 1099-Misc -- which includes the name and Social Security number of the person providing the care -- is issued. The employee then is responsible for reporting the income on IRS Form 1040 Schedule C, and if net earnings are $400 or more, IRS Schedule SE for Social Security and Medicare taxes also must be filed.
To learn how this might affect either person's Social Security benefits, please check with the Social Security Administration.
Also, see both IRS Publication 926, "Household Employer's Tax Guide," and 2003 Instructions for Schedule H (Form 1040) for additional information.
Harrell: An individual who is paid cash wages of $1,400 or more to perform such domestic duties is considered a household employee. As a result, the wages are subject to employment taxes -- and it does not matter if the payments originated from medical reimbursements.
The employer is responsible for withholding Social Security (6.2 percent of wages) and Medicare taxes (1.45 percent) from the employee's check and also must pay an additional share of Social Security and Medicare taxes at the same rates along with federal unemployment tax.
The employer is not required to withhold federal income taxes unless asked by the employee. If the applicable taxes have not been withheld from the employee's wages, it ultimately is the employer's responsibility to pay both shares of the taxes (a total of 15.3 percent of wages). To determine how much taxes are owed, the employer needs to complete Schedule H "Household Employment Taxes" and include that amount on line 59 of their Form 1040.
The employer should have issued a W-2 form to the employee and sent a copy to the Social Security Administration. Since the wages reflected on the form will need to be included on the employee's tax return, some of their Social Security benefits may become taxable income. The worksheet for line 20 of Form 1040 will calculate how much, if any, of the Social Security benefits will be taxable.
Your friends should review Publication 926, "Household Employer's Tax Guide," carefully to become familiar with the tax requirements of having a household employee. This also includes obtaining a federal identification number to be used on the forms that report the employee wages.
I am divorced with one child. One parent provides more than half of the child support, while the child resides over half of the time with the other parent. Can one parent claim the child as a deduction, while the custodial parent claims the child for earned income credit calculation?