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Posted January 9, 2007

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Taxes: Why is Independent Contractor Status Important?

Q. I will be hiring someone for two days per week to care for my husband who has Alzheimer's disease. I was referred to this person by an agency to which I will pay a fee if the trial period is successful. I notice in a posting of June 16, 2006, regarding taxes that mention is made of hiring someone as an independent contractor rather than as an employee.

Why is independent contractor status important, and does it have any bearing on liability insurance?

Barbara, Brooklyn, New York.

A. When a person is hired as an independent contractor, there is usually a contract and specific duties outlined. The contractor is responsible for his or her own taxes, including self employment tax on net earnings. The person for whom the contractor works would issue a Form 1099-MISC to report the gross earnings.

If the person is actually an employee, even part-time, the person for whom they work is responsible for payroll taxes -- Medicare and Social Security taxes, as well as unemployment tax at the federal and state levels (if earnings exceed the annual reporting levels). A workmen's compensation policy might also be required by the state. The employer would issue a Form W-2 and the federal payroll taxes would be remitted with the employer's Form 1040 on Schedule H.

Most times, the Internal Revenue Service will take the position that the worker is an employee, and there are a number of factors that they look at to determine this. If you pay an agency, rather than the worker for the time worked, then there is no issue, because the worker is an employee of the agency. If you hire the worker directly, that is when the contractor/employee status becomes an issue. You may recall when the so-called "nanny tax" became a big issue a few years ago because parents were not reporting the earnings of the nanny's who were taking care of their children at home. Whether the person who is being cared for is a child or an adult does not matter; what matters is whether they are an employee.

You may want to check the IRS website and review Publication 926, Household Employer's Tax Guide, as well as the instructions for Schedule H (Form 1040).

This answer has been provided by Carol I. Katz, MS, CPA/PFS, CFP, CVA, the Deputy Tax Director at Leonard J. Miller & Associates, Chartered, in Baltimore, Maryland. Carol Katz works exclusively in the tax and financial planning areas, has been published in professional journals and has discussed tax issues on television and public radio. She can be reached at carolkatz@lenmiller.com.

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