Q: Tax Playa, I have a nanny come by to take care of my kids, and I pay her out of pocket. Should I be worried about owing any sort of "nanny tax"?
Jen, Washington DC
A: Yes, you should. Don't take my word for it. Bill Clinton's first two attorney general nominees (Zoe Baird and Kimba Wood, for trivia buffs) were scuttled because they didn't pay taxes on their "household employees." You must pay payroll tax for any household employee you hire...
For more information on this topic, please consult IRS Publication 926, Household Employer's Tax Guide.
If you hired someone to do household work and controlled the work he did and how he did it, you are a household employer. Examples of household work include but are not limited to: babysitters, caretakers, cleaning people, drivers, health aides, housekeepers, nannies, private nurses, and yardworkers.
If you hire a corporation or other separate tax entity (as opposed to a person), you don't have anything to worry about in this respect. It also goes without saying that you can get into a lot of hot water for hiring an undocumented worker who may be here without legal status.
If you pay a household employee more than $1500, you need to withhold and pay Social Security and Medicare taxes. If you pay a household employee more than $1000 in any calendar quarter, you also need to pay federal unemployment tax. State payroll taxes may also apply, and usually do.
For purposes of federal unemployment tax, do not count your spouse, your under-21 child, or your parent. For purposes of Social Security and Medicare taxes, also do not count anyone under the age of 18.
It is up to you whether you want to withhold federal income tax for the household employee.
You will need to get an employer ID number if you are a household employer and include it on the special Schedule H form. This can be done easily and automatically at the IRS.gov website. You will also need to file a W-2 with the Social Security Administration and give a copy to your employee if you paid more than $1500 in cash wages or withheld income tax.
How Most Taxpayers Can Be Compliant
Most of the time, the situation for taxpayers is that they have paid a gardener or a maid/nanny a few thousand dollars over the course of the year. These situations are easily dealt with at tax time. There is normally no need to do quarterly filing. At most, a W-2 may have to be given to the employee and filed with SSA in January if more than $1500 was paid. An EIN will have to be obtained, and you'll need to register with your state employment commission to pay state unemployment tax.
As an attachment to the employer's 1040, the Schedule H is added and extra tax is tacked on. The purpose of the Schedule H is to remit payment to the government for Social Security, Medicare, and unemployment tax. On the first two, you are paying both halves of Social Security and Medicare tax. As a result, you should withhold half of this tax from the money you give your employee. Their half of Social Security and Medicare tax will be 7.65% of their wages, so withhold $76.50 for every $1000 you pay them.
If you qualify otherwise, the cost of having a household employee counts toward the child and dependent care tax credit (see the topical index to the right for more on this).