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What You Need to Know About the So-Called “Nanny Tax”

September 28, 2015

Paying nannies and household employers “under the table” is a risky move - Learn how you can be IRS compliant when hiring household help.

Something overlooked by many people who hire domestic workers is the tax and legal liability considerations of hiring household help- the “nanny tax” as it is often called. According to the IRS, if you pay above a threshold amount to a household employee, you have payroll, tax and HR obligations that need to be implemented at the start of hire, and maintained throughout the year. If you neglect to do so, you are violating labor laws and could be charged with expensive penalties as a result.

Who counts as a household employee?

Despite the name, the “nanny tax” applies to more than just nannies. Some examples of other household employees:

  • Babysitters,
  • Caretakers,
  • House keepers,
  • Cooks,
  • Drivers,
  • Health aides.

Important payroll considerations for household employees

The IRS says that if you pay any household employee $1,900 or more during a calendar year, there are tax and payroll responsibilities. You will need to collect the following things to pay nanny taxes:

  • Payroll information - It is important to calculate your employee’s gross pay, taxes withheld and the corresponding employer taxes each pay period.
  • ID numbers - You will have to apply with the IRS for federal employer identification number (FEIN) so that you will be able to report payroll taxes. With your FEIN, you can then go to the tax agency in your state to acquire your state identification number.
  • Forms - By the end of January each year, you must give your household employee a Form W-2. Form W-3 as well as Form W-2 Copy A to the Social Security Administration. There are also required year end forms depending on what state you live in.
  • Quarterly Filings - On a quarterly basis, you should file state tax returns and send 1040 estimated payments to the IRS.

Important considerations for workers

Make sure your household employees know that they have responsibilities regarding taxes as well. There are three important forms your employee should complete:

  1. Form I-9- This form verifies that the household worker is eligible to work in the U.S.
  2. Form W-4- This is completed by the employee and determines the amount of his/her tax withholdings.
  3. Employment agreement- It is helpful to draw up a work agreement between you and your employee - this way you have everything documented- the work schedule, compensation agreement, tax withholding/reporting, etc.

It is just not payroll

You will need workers’ compensation coverage. If they drive your car, you will need to add them to the auto insurance policy. If they work for you in your Winter home, you will need to get for example, Florida or Arizona, workers compensation coverage.

Beware of overtime at time and a half. If you hire someone for a 12-hour day, at $25 per hour, and pay him or her $300, you are short by $50! This is where most problems begin. When that person leaves your employment, they go to collect unemployment and it is determined that you failed to pay overtime. Now the labor attorneys have a field day. Can you say big damage, attorney’s fees and costs!

Some people might be tempted to simply pay household employees “under the table” to save time and stress regarding IRS rules and regulations. However, by doing so, keep in mind that once you no longer need your nanny or household employee and let him/her go, they could file for unemployment benefits, which requires a list of past employers. Once your name is listed as a reference and the unemployment office is unable to find any tax returns that you’ve filed, not only will your past employee not receive benefits, but you will face an audit from the state and other possible penalties as well.

Questions? Contact any member of our Tax Services Team.

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