The Nanny Tax Returns—Be Ready

Although it now seems to be oneof many things that wrecked thenomination of Bernard Kerik tobe the nation's Secretary of HomelandSecurity, the nanny tax had reared itshead again. (Kerik's problems are compoundedby the fact that his nanny wasan illegal alien.) And IRS statistics suggestthat many other American families aren'tbothering with nanny law compliance.

Thanks in large part to the rise of thetwo-income family—many physician-readershave told our editors that both spousesin their marriage work—the issue takes oneven greater significance. So, if you have asitter for your children, a driver, a healthaide for a family member, or a housecleaner,you need to know about the nanny tax.

Tax Details

The nanny tax is a federal law thatrequires you to pay employment taxes—including Social Security, Medicare,Federal unemployment taxes, and stateunemployment and disability taxes—onhousehold employees. In 2003, the IRSreceived approximately 240,000 nannytaxforms, although tax officials agreethat the number of household employerswho should be paying the tax is closer to3 million. And the number of individualswho actually pay the nanny tax has beenin steady decline for the past 7 years.

The real hullabaloo began back in1993, when Zoe Baird was tapped byPresident Bill Clinton to become USAttorney General. However, reports thatshe had neglected to pay the nanny taxderailed her chances. The reports alsoresulted in an increase, albeit brief, inthe number of nanny-tax filers. Today,the number of filers represents less than1% of all individual returns filed.

In 1994, responding to this negligenceon the part of many household employers,Congress changed the law. Whileproviding for some exceptions, the newlaw requires payroll tax filings by thosewho pay a household employee morethan $1400 in wages in 2005 (that's aridiculous $27 per week). It also requiresthat employers report any employmenttaxes on their federal income tax returns.Failure to do so could result in substantialpenalties, including imprisonment ifcriminal fraud is determined.

As a household employer, the payrolltaxes you're required to pay include:

• Social Security—6.2% is withheldfrom the employee and matched up to$87,900 in wages by the employer.

• Medicare—1.45% is withheld fromthe employee and matched with no limitin wages by the employer.

• Federal unemployment taxes—Employerspay 6.2% on the first $7000 inwages, but it is reduced by a credit of5.4%, resulting in a net tax of 0.8%.

• State unemployment and disabilitytaxes—Employers are responsible for thepayment of both their share and theiremployees' share.

It doesn't matter whether the work isperformed full-time or part-time, orwhether you pay on an hourly, daily, orweekly basis. If you determine not onlywhat work is done, but also how it is done,chances are the worker is an employee.

Some Latitude

In contrast, if the worker belongs to anagency and you pay the agency directly,the agency is responsible for the payrolltaxes. Similarly, if the worker offers theirservices to the general public, controlswhen the work is done (eg, someone whomows your lawn or cleans your house),and works for several households, theworker is considered self-employed, andis responsible for the taxes.

There are, however, some exceptions.Don't count any pay toward SocialSecurity or Medicare wages if you pay it toyour spouse or any of your children underage 21. Also, don't count most employeesunder age 18. The exception in this latterarea, according to the IRS, is that you docount the wages if the employee underage 18 is providing those household servicesas their principal occupation.

Good news:

Depending on the workdone by your employee, the paymentsyou make might qualify you for a childcarecredit. It's best to check with a taxprofessional, but if you have a dependentchild receiving care, you couldreceive an income tax credit of up to35% of your expenses.

For more information, visit the IRSWeb site (www.irs.gov/publications) andreview Publication #926, "Do You Have aHousehold Employee?"