The so-called nanny tax received a flurry of interest early in the Clinton administration when the president’s first choice for attorney general had to withdraw when her failure to pay payroll taxes for her household employee came to light. Since then, interest in the nanny tax has died down; however, the laws governing these taxes remain a real concern for those with household employees — and a real threat to those who ignore them. First of all, let’s define the nanny tax. It isn’t a single tax, but rather a collection of payroll taxes that all employers — including household employers — are obligated to pay. The taxes included under the nanny tax umbrella are:
• Federal unemployment taxes. Employers must pay 6.2 percent of the first $7,000 in wages paid to an employee. This amount is reduced by a credit of 5.4 percent, however, resulting in a net tax of 0.8 percent, provided that you have paid all required state unemployment and disability taxes.
• State unemployment and disability taxes.
• Social Security. This is the most expensive of the taxes. Both the employer and the employee must pay 6.2 percent on up to $76,200 in wages earned in a year.
• Medicare. Both the employer and the employee must pay 1.45 percent of the employee’s income for Medicare taxes.
An employer may choose to pay the employee’s share of the Social Security and Medicare taxes. The amount paid must be added to the employee’s wages when they are reported to the government.
Who is and is not an employee?
Don’t be misled by the name “nanny tax.” Social Security, Medicare, federal unemployment, state unemployment and disability taxes do not apply only to nannies. Anyone who works for you in or around your home and to whom you pay more than $1,200 for services in a calendar year may qualify as an employee. You are not required to make payroll tax payments on any wages paid to your spouse, your children under age 21, your parents (in most cases) or to any worker under the age of 18, so long as providing household services is not that person’s primary occupation. In addition, if the person providing the services is an independent contractor instead of an employee, you do not need to make payroll tax payments on his or her earnings.
Unfortunately, there is no single definitive test for determining whether a household worker is an independent contractor. In general, if workers set their own hours, provide their own supplies and perform similar services to other households, then they are likely to be considered independent contractors. On the other hand, if you determine when and how they will perform their services and if you provide their supplies, then they are likely to be considered employees. If a household worker has given you a business card or flier promoting his or her services, has submitted invoices for payment or provided other documents that indicate that he or she is an independent contractor, it is a good idea to keep such documents with your tax records. Household workers provided by agencies also are not employees (at least as far as you are concerned). Since the worker is employed by the agency, not by you, payroll taxes are the agency’s concern.
Tax withholding and reporting
While most employers are required to withhold income taxes for their employees, household employers face no such requirement. You need only withhold income taxes if the employee asks and you agree. But be aware that withholding adds further compliance burdens. For example, you will have to ensure that employees fill out W-4 forms. You also will have to issue W-2 forms and might even have to make advance payments for an employee’s earned income credit. Employers who withhold can face penalties if they do not properly remit withheld funds. Therefore, many household employers prefer not to withhold.
Prior to 1995, payroll taxes for household employees were paid quarterly through special tax filings. Now, however, these taxes are paid by filing Schedule H along with your personal income tax return. Because the paperwork concerning nanny taxes is now part of your federal income tax return, failure to make appropriate filings and payments affects the validity of your return, increasing the importance of handling these taxes appropriately.
IRS Publication 926, Household Employers Tax Guide, is an excellent resource for questions related to federal rules and filings. You can access this publication through the IRS Web site at irs.gov or you can call the phone number listed in the government section of the telephone book.