All about the Nanny Tax

Paying your nanny and tax reporting

Taxes. It's one of the big questions in nanny hiring. How do you handle it? You may be tempted to forego paying taxes and choose to pay jobs under the table, but frankly, with someone working for you as much as a nanny does, that's risky. You may eventually get flagged for a tax audit-something you obviously want to avoid. If you pay your nanny - or any household employee, for that matter - more than $1600 in 2008, then you need to report them when you file your taxes. But, it's not just about the amount your nanny makes; it's her employee status that really matters.

Is your nanny an employee?

In short, yes. According to the IRS, a person is an employee if you have control over what they will do and how they will do it, as opposed to an independent contractor for whom you control only the result of their work. The behavioral and financial aspects of your nanny's job, as well as the type of relationship you have with her, are all included in the IRS's description of what defines an employee. Your nanny's status as an employee impacts your tax obligations.

So, take a deep breath-here are the basics from the IRS:

• The "nanny tax" is comprised of (1) Social Security and (2) Medicare combined, referred to as FICA, and (3) federal unemployment tax, known as FUTA.
• The FICA tax equals 15.3% of wages and is generally split between the employee and employer. However, most people do not withhold the nanny's half, which means the employer is responsible for the entire amount come tax time.
• The FUTA tax is due on the first $7,000.00 of your nanny's wages for the year but only if you paid $1,000.00 or more for any calendar quarter for the current or preceding year and the nanny is not your parent, spouse, or person under the age of 21.
• You need to use a Schedule H (Household Employment Taxes) to calculate and report your nanny's wages to the IRS.
• You need an employer ID number (EIN) in order to do your nanny tax reporting. Get one by filing a Form SS-4.
• You must provide your nanny with a Form W-2.
• You will need a Form W-3 when filing a copy of your nanny's W-2.
• Get all tax forms directly from the IRS by calling 1-800-829-3676 or by visiting the IRS website.
• Additional state-specific requirements exist for household employers and vary depending on your state of residence. Consult the tax section of your state government's website to look up the specific household employer rules where you live.

Learning about household employment

Even the basics can seem confusing, so be sure to check out the Household Employer's Tax Guide, known fondly as Publication 926. This guide takes you through the "all you needed to know but were afraid to ask" information you need about nanny taxes. It's well organized and includes helpful tips, explanations, and a Household Employer's Checklist. Don't be intimidated by this document. It answers 9 major nanny tax reporting questions and includes an index, list of other tax publications and forms, and information about where to get tax help. The major questions reviewed are:

• Do you have a household employee?
• Can your employee legally work in the United States?
• Do you need to pay employment taxes?
• Do you need to withhold federal income tax?
• What do you need to know about the Earned Income Credit?
• How do you make tax payments?
• What forms must you file?
• What records must you keep?
• Can you claim a credit for child and dependant care expenses?

Benefits of paying employees or your nanny above board

Within the nanny industry, there's an underlying concern that many people don't understand the benefits of paying a nanny "above board." The prevailing idea is that proper nanny salary and tax reporting create financial hardship both for the employer and the nanny. And, with the work needed to set up the reporting properly, many people just decide to forget it and pay their nanny "under the table." The good news from the field is that both families and their nannies benefit from proper tax reporting. Employers are eligible for tax breaks, such as the Dependant Care Account, to offset the cost of the taxes. Nannies are able to take advantage of the benefits available to most working people, such as Social Security, unemployment, disability, and more. But, employers can only benefit from the tax breaks if they are paying their nanny legally.

What can happen if you pay your nanny "under the table?"

Maybe nothing...at least for a while, until you get caught. What's the risk? Here's the list of possibilities: tax evasion charges, back taxes with penalties and interest, liability for the employee portion of FICA, and in some cases loss of professional license. If you can't imagine what would bring about such a scenario, here's a simple example. Your nanny works for you for several years receiving under the table pay. ??When the kids are in school full time, you decide to part ways since her services are no longer needed. She files for unemployment and is required to list her past employers, which includes your family as well as others. Unemployment reviews the case and finds your family didn't file any tax returns or pay into unemployment. Your ex-nanny is refused benefits and you're landed with a state and federal tax audit. And don't try running your nanny's payroll through your business either-it's illegal. As of April 2006, the IRS has started to crack down on employers who pay cash or under-report via misclassifying their employees as independent contractors.

Our recommendation is to opt for the peace of mind that comes with knowing you're abiding by the law. Paying your nanny properly, and legally, ensures a healthy, long-term relationship and protects both of you from an expensive and possibly damaging tax audit or refusal of benefits.