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Liable for Nanny Taxes on Household Help?
David A. Stiefel, MBA, CPA/PFS
Principal, Tax Services; Principal, Accounting and Assurance Services
February 9, 2009
"We made too many wrong mistakes," to quote Yogi Berra. He probably wasn't speaking for the one-million-plus Americans who employ nannies, or the many more that hire other household help. But he could have been!
Estimates are that an extraordinary 80 or 90 percent of these employers do it wrong, including such well-known people as Timothy Geithner and Nancy Killefer. Some fail to pay or withhold taxes, others run afoul of unemployment or insurance requirements, some even miss issues with an employee's legal status. As a result, at least 800,000 nannies alone are paid illegally each year.
In some instances, it's simply a matter of confusion over the admittedly complex requirements. In others, it's a conscious choice to save money and paperwork by avoiding taxes and related reporting requirements.
The truth is, even with the best of intentions, it's easy to make a mistake navigating the network of federal and state requirements―and the cost of making a mistake can be substantial.
If you're caught breaking the law by paying your employee under the table, the back taxes, penalties, and interest can be considerable. Federal penalties can potentially include the loss of a professional license. All it takes is a former employee filing a claim for unemployment benefits, for example, to trigger an investigation.
If you don't properly account for your household employee, you lose out on any federal tax benefits for which you may qualify if you pay your employee legally.
Properly reporting wages and paying taxes can also make a big difference to your nanny or other household employee. If you don't properly report and account for your employee, she or he may not be able to establish credit-worthiness and won't be eligible for important benefits such as unemployment insurance, Social Security, and the earned income tax credit, among others.
So, how do you know if your nanny is an independent contractor, or an employee and you an employer? If you are an employer, what are you legally required to do in order to avoid penalties and qualify for tax benefits?
Definitions
 Household Employee: If you hire a person to do household work―e.g., a nanny, housekeeper, maid, private nurse or health aid, yard worker, caretaker, or driver―and you control both what work is done and how it is done, that person is your employee. According to the IRS, it doesn't matter whether the person is a part-time or full-time worker; paid by the hour, day, week, or job; or hired through an agency.
Cash Wages: Cash wages include the money you pay to your household employee in cash, or by check or money order. They do not include in-kind payments such as room and board or clothing.
Checklist of Employer Responsibilities
If you don't already have one, you'll need to obtain a federal employer identification number (EIN) from the IRS to report and pay employment taxes. You can apply online at http://www.irs.gov/businesses/small/article/0,,id=102767,00.html.
You must ensure that the person you intend to hire can legally work in the United States. Before you employ him or her, your potential employee must complete the following IRS forms: Form W-4, Employee's Withholding Allowance Certificate and the employee section of Form I-9, Employment Eligibility Validation. You should review these entries and also complete the employer section(s) of Form I-9. You'll find the W-4 form online at http://www.irs.gov/pub/irs-pdf/fw4.pdfhttp://www.uscis.gov/files/form/I-9.pdf.
If you pay a household employee more than specified minimum amounts, you're required to pay federal employment taxes that include Social Security, Medicare, and unemployment.
If you pay a household employee more than a specified amount per quarter, you're required to pay state employment tax.
As an employer, you may also elect to pay state worker's compensation insurance for your household help.
You're responsible for processing your employee's payroll and satisfying a number of federal and state reporting and filing requirements, many of which are due quarterly. You'll also need to file Schedule H with your federal income tax return, and remit both the taxes withheld and your share of the taxes.
Employment Taxes
If you pay a household employee more than $1,700 in 2009, you're required to withhold and pay Social Security and Medicare taxes. Exceptions include payments to your spouse, child under age 21, parent, or employee under the age of 18.
If you pay your employee more than $1,000 in total cash wages during any calendar quarter of 2008 or 2009, you're required to pay federal unemployment. Exceptions include payments to your spouse, child under age 21, or parent.
Social Security (FICA) and Medicare: The tax is 15.3 percent of cash wages, with 7.65 percent considered to be the employee's share and the remaining 7.65 percent the employer's share. However, some employers pay both portions of the tax for their household help.
Federal Unemployment: The tax is calculated as 0.8 percent of wages each year, up to a maximum of $7,000 in wages per employee.
State Unemployment: If you pay your employee more than $1,000 in gross wages in any calendar quarter, you'll need to register as a business in Washington state by filing a Master Business Application (http://www.dol.wa.gov/forms/700028.html), and report new hires (http://www1.dshs.wa.gov/newhire/). The unemployment tax rate for employers in the state of Washington is based on an experience-rate system, with an average rate of 1.7 percent (for 2008). For more information, refer to the Washington State Employment Security Department website, online at http://www.esd.wa.gov/uitax/index.php.
Insurance
Although the rules vary from state to state, Washington's workers' compensation insurance is mandatory if you have two or more full-time employees. Anything less and this insurance is optional.
If you fall into the optional category, don't opt out of the workers' compensation program without considering the potential risks. If your nanny or other household employee is injured while working for you, your own insurance may not cover such injuries and the financial implications to you can be quite significant. Be sure to consult with your own insurance company before you make a decision.
Tax Benefits
To assist you with the cost of employing household help for certain children or other dependents, you may qualify for either of the following tax benefits:
Tax Credit for Child and Dependent Care: If you qualify for this federal tax credit, you can reduce your federal tax liability by a percentage of every dollar you spend on household help―including the wages and federal and state employment taxes that you pay. The percentage ranges between 20 and 35, depending on your adjusted gross income.
To qualify, your household employee must provide care for a child under the age of 13, a spouse, or another dependant who is "not capable of self-care." You cannot qualify for the credit if you participate in a dependent care assistance plan during the year.
The maximum annual dollar limit is $3,000 for the care of one qualifying person and $6,000 for the care of two or more persons, subject to earned income and other requirements.
Dependent Care Assistance Plan or Dependent Care Flexible Spending Account: If your employer offers this benefit, you can pay eligible expenses―including childcare for children under the age of 13 and certain dependents who are incapable of self-care―using pre-tax dollars from the account. The maximum amount you can place in the account each year is $5,000 ($2,500 if married filing separately), and other restrictions may apply.
Have More Questions?
For more information on your responsibilities as an employer, refer to the latest version of IRS Publication 926 Household Employer's Tax Guide, online at http://www.irs.gov/pub/irs-pdf/p926.pdf.
If all this sounds like more than you're ready to manage yourself, even with the assistance of your Bader Martin advisor, you can always hire one of a number of companies to do it for you.
and the I-9 form at
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