What You Need to Know Regarding Household Employees (The Nanny Tax)

July 7, 2017

What You Need to Know Regarding Household Employees (The Nanny Tax)

One of the most underreported tax liabilities is the reporting and payment of employment taxes of household employees, often referred to as the “Nanny Taxes”.  Most experts put the noncompliance rate at around 80%.  Probably the biggest reason for noncompliance is that most taxpayers don’t know the rules.

Do I Have a Household Employee?
Most taxpayers don’t realize they have a household employee.  A household employee could be the neighbor you pay to watch your children until you get home from work or the landscaper who cuts your grass weekly.  You have a household employee if they work in your house and you control who does the work, when the work is performed and how the work is performed.  If you pay a company/agency that provides their employee to perform the work or the worker is self -employed then they wouldn’t be considered your employee.  You can’t just have an agreement that states the worker is self-employed or just give them a 1099 at year end.  The IRS will look at the specific facts to determine if the worker is an employee or is truly self-employed.  More information about who qualifies as an employee verses self-employed can be found in the IRS publication 926.  If you still are not certain whether the worker is an employee or self-employed you can ask the IRS to make a determination by filing IRS form SS-8.

I Have an Employee, Now What?
For 2017 any individual who pays wages of $1,000 or more in any calendar quarter is required to pay federal unemployment tax and if you pay any one household employee $2,000 or more a year you are required to withhold and pay social security and Medicare taxes.  You don’t have to count wages paid to your spouse, child under 21 or parents.  Also, for any employee under 18 at any time during the year you are exempt from withholding and paying social security and Medicare taxes. If you meet the above limits then you need to do the following four steps:

  1. Establish yourself as an employer with your state and the IRS.  You can apply for a Federal Employer Identification Number (FEIN) by going online at www.IRS.gov.
  2. Be sure to withhold the social security, Medicare, federal, state and local taxes from the employee’s paycheck.  For social security and Medicare both the employee and the employer pay 7.65% of compensation or a combined total of 15.3%.  Some employers will just pay the entire 15.3% to avoid the withholding calculations.
  3. On a quarterly basis all employers must remit the federal, state and local taxes withheld. Most states also require a quarterly unemployment tax return to be filed.
  4. At year end you must provide a W-2 to your employee, the IRS and state and file IRS schedule H with your personal Form 1040.

One option to simplify the payroll procedures is to engage a payroll company to prepare the paychecks and to keep you compliant.  One big caution is that the payroll service needs to be informed that the payroll is for household employees, which has different filing requirements than business employees.

Wow, That Sounds Complicated and Costly – What is the Cost of Noncompliance?
Obviously there’s no cost until you get caught.  Probably the biggest chance of getting caught is when a household employee losses their job and they attempt to file for unemployment.  That’s when the government realizes there is no record of the employee working because you didn’t file the required reports.

Violators are subject to paying the back taxes as well as penalties and interest for as long as an employer fails to be compliant.  Depending on how much money is owed and the number of years being assessed, the penalties and interest could easily double your liability.  There have been many cases where the total tax, penalties and interest have amounted to thousands of dollars.

It’s complicated to determine who is a household employee and there is the time and cost of complying with all the rules and regulations, but the interest and penalties of not complying can be large.  The above is just a general overview of the rules.  Please call or schedule a meeting with your Herbein accountant to discuss your specific situation.

For additional information contact Larry Vasko at ljvasko@herbein.com.