Should the child care provider hire her relative as an employee or not?
Although this is a complicated situation, my simple answer is to not hire a relative as an employee (with a limited exception). Instead, give money to the relative as a gift and don’t treat it as a business transaction.
As a general rule, if you hire someone to help you care for the children in your care you must treat this person as your employee, not as an independent contractor. This involves a number of federal and state payroll tax and insurance issues.
On the federal level you must withhold Social Security/Medicare taxes, withhold federal income taxes, pay annual federal unemployment taxes, and file a series of quarterly and annual payroll tax forms.
On the state level you must withhold state income taxes (unless your state doesn’t have income taxes), pay state unemployment taxes, and purchase workers compensation insurance. Since state laws vary widely in this area, check with your state department of revenue and workers compensation office to find out your responsibilities.
Holy cow! What a pain in the neck. Many child care providers fail to follow these rules and put themselves at risk for an IRS or state tax audit and for paying thousands of dollars in medical bills and penalties for not having workers compensation insurance.
You must treat such workers as employees regardless of how little you pay them or how few hours they work. There is no rule that says you can pay someone less than $600 a year and treat them as an independent contractor.
The only exception to this rule is if the person doing the work is operating as a self-employed business providing substitute care. Such a person would need to have a business name registered with the state, have a business identification number, work for a number of different child care providers, and use their own contract. Also, if a person comes into your program to conduct an activity (music lesson, puppet show, etc.) this person would be considered an independent contractor, not an employee.
If you do follow all the rules and hire an employee you can deduct the cost of the wages and all federal and state taxes and insurance as a business expense. The relative must report her wages as taxable income.
A Better Way
Rather than hire your relative, tell them that you won’t pay them for the work they do for you. Instead, give them a gift of cash or clothing as a loving daughter, sibling, or mother. You aren’t paying them for their work. You are giving them a gift. When you do this you can’t deduct the gift as a business expense and the relative doesn’t have to report the gift as taxable income. You aren’t breaking any IRS rules if you do this. It’s all on the up and up. I’ve spoken directly with an IRS officer about this and she reassures me that the IRS would not try to turn this into an employer-employee situation. The only time I would suggest you consider hiring a relative is if this person is working for you on a full-time basis or on a regular part-time basis throughout the year. Unless this person doesn’t mind working for no pay and receiving occasional gifts from you, I think the longer hours makes it more likely you should treat this as a business relationship.
Note: After talking with another IRS official (!), I’ve learned that it’s not a good idea to exchange work for gifts as I described above. If you do this, the IRS is likely to conclude that this was payment for your work and treat this as an employer/employee relationship.
Hiring Your Own Children
One note about hiring your own children: If you hire your own child who is age 18 or older you still must withhold and pay Social Security/Medicare taxes and withhold federal and state income taxes. But you won’t owe federal unemployment taxes. Contact your state for your state rules. As a result, I believe it makes more sense to give this child gifts, unless you want your child to learn what it’s like to be an employee.
If your own child is under age 18 there is no Social Security/Medicare taxes, no state or federal tax withholding and your child care earn up to $5,700 and not owe any federal income taxes. Therefore, there is a tax benefit to your family in that you can deduct the wages you pay and the child probably won’t have to pay any taxes. As a result, you may want to treat your younger children as employees.
This is the first of a series of articles on hiring workers for your business.
See also: “Are Helpers Your Employees or Independent Contractors”, “What is an Independent Contractor”, “Your Payroll Responsibilities as an Employer”, “Do You Need Workers’ Compensation Insurance?” and “When Hiring Your Husband Makes Sense.”
So – maybe it’s time to talk to your relatives about how they would feel about getting gifts from you.
Image credit: speedysigns.com
For further information about how to file all the federal payroll tax forms if you do decide to hire employees, see my Family Child Care Tax Workbook and Organizer.
Copyright 2011, Tom Copeland, www.tomcopelandblog.com