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| The Basics | Grow up and pay the 'nanny tax' if you owe it
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The "nanny tax" evokes fear and loathing among people who hire workers for in-home services. Here are some strategies on how to both stay honest and reduce the tax tab.
By Jeff Schnepper
If you hire someone to mow your lawn or to take care of your children, you need to know about the "nanny tax" and when you're responsible for paying it.
The nanny tax is the federal requirement that you pay the employment taxes on household employees. This column will explain the tax to you and guide you through its complexities.
In the mid-1990s, Congress took a closer look at the nanny tax, suspecting that many employers weren't paying the tax for their domestic help. A 1994 analysis found that of the 2.5 million household employers in the United States, only 500,000 had paid the required taxes.
To clamp down on the deadbeats, Congress changed the law, providing for some exceptions, but also requiring that employers report any employment taxes on their federal income tax returns. Failure to report these taxes could mean substantial penalties and interest and, if criminal fraud is found, imprisonment.
Specifically, the law requires payroll tax filings if you pay a household employee more than $1,400 in wages in a calendar year. If you pay each household worker less than $1,400, neither you nor the employee will owe any federal payroll taxes on those wages.
What counts is when the wages are paid, not when the services are rendered. That means that if you are close to the limit, it might be worthwhile to both you and your employee to wait until next year to transfer that final check. Even if you have to "lend" the money for a short period, the tax savings may be worth it. On $1,401 in wages, the federal taxes are $140.
Here are the payroll taxes you're obligated to pay:
- Social Security. 6.2% is withheld from the employee and matched by you for up to $90,000 in 2005 and $94,200 in 2006. These taxes, mandated by the Federal Insurance Contributions Act, and known as FICA on your payroll check, provide for a federal system of old-age, survivors and disability insurance for workers and their families.
- Medicare. 1.45% is withheld from the employee and matched by you with no limit in wages. These taxes pay for hospital insurance when you reach age 65.
- Federal unemployment taxes. You pay 6.2% on the first $7,000 in wages, but this amount is reduced by a credit of 5.4%, resulting in a net tax of 0.8% if you paid all your required state unemployment/disability taxes.
- State unemployment and disability taxes. You are responsible for the payment of both your share and your employee's share. If you don't withhold, you are still responsible for these taxes.
You need to pay these taxes for your "household employees." Household work is done in and around your home by nannies, babysitters, health aides, private nurses, house cleaners, caretakers, yard workers and similar domestic workers.
Your employee vs. self-employed
The taxes only apply to your "employees." A household worker is your employee if you can control not only what work is done, but how it is done. It doesn't matter whether you pay on an hourly, daily or weekly basis or by the job. It doesn't matter whether it's full-time work or part-time work. If you have control, the worker is an employee.
However, if you pay an agency directly, and the agency is the employer of the worker, the agency pays the payroll taxes. Alternatively, if the worker controls how and when the work is done, and works for several households, the worker may be self-employed. If the worker offers his or her service to the general public and has his or her own tools and supplies, that worker should be self-employed and responsible for the taxes.
For example, if you hire a babysitter who does light housework (and please let me know where you found her), she's probably an employee. Alternatively, if your lawn cutter has her own lawn mower and provides landscaping services to others, then she probably is self-employed.
Some household employees who want the advantage of being self-employed establish their own businesses with an employer identification number (EIN). This number is different from their Social Security number. For example, a house cleaner who has a separate EIN and receives checks made out to Smith Cleaning Services rather than to Jane Smith, will most likely be an independent contractor rather than an employee. No incorporation is necessary, but the worker will be responsible for all appropriate taxes on the worker's own tax return. Smith Cleaning Services would file a Schedule C and a Schedule SE to attach to Jane Smith's 1040.
There are exceptions. Don't count any pay as Social Security or Medicare wages if it's paid to any of the following:- Your spouse.
- Your children under age 21.
- Your parent, except if both the following conditions apply:
1) You have a child living with you who is under age 18 or who has a physical or mental condition that requires the personal care of an adult for at least four continuous weeks in a calendar quarter; and
2) You are divorced and not remarried, or you are a widow or widower, or you are married and living with a person whose physical and mental condition prevents him or her from caring for your child for at least four continuous weeks in a calendar quarter.
- An employee who is under age 18 at any time during the year, except if providing household services is the employee's principal occupation. For example, a student's "principal occupation" is not providing household services, so you would not have to pay FICA and Social Security taxes for a high school student who is working for you as a babysitter, even if the wages exceeded $1,400.
Having to pay household taxes is not all bad news for you as the employer. Appropriate payments to domestic employees, including those to a person to clean your house, might qualify for the child-care credit. If you have a qualifying child, you could get a tax credit of as much as $600. A credit is a dollar-for-dollar reduction in your tax.
No matter how much income you have, the minimum child-care credit is 20% of as much as $6,000 in qualifying expenses for two children. For one child, it would be 20% of up to $3,000 in qualifying expenses.
Even if you don't qualify for the credit, you should still file and pay any tax due. Not reporting payments could cost you big bucks in terms of penalties and interest. Besides, it's against the law.
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