Taxes Time to Come Clean
by Kevin McCormally
Bernard Kerik seemed straight out of central casting when he was nominated to take over the Department of Homeland Security. Until, that is, we learned that President Bush’s first choice to replace Secretary Tom Ridge couldn’t run his own household legally. Instead of taking on terrorists, tough-guy Kerik was felled by the Mary Poppins tax.
His case threw the nanny tax — the collection of federal and state rules that apply to household employers — back into the headlines, and surely sprinkled a bit of anxiety among the tens, or maybe hundreds, of thousands of Americans who share Kerik’s dirty little secret. No one knows for sure how many people ought to be paying social security, medicare and unemployment taxes for their child- or elder-care providers, housekeepers and other household employees; one estimate puts the number at two million. But fewer than 240,000 taxpayers filed the nanny-tax form with their 2002 tax returns (the latest year for which figures are available). Hmmm.
If you had a household employee in 2004, you still have time to comply with federal rules. Schedule H, on which you calculate your federal nanny tax, goes with your income-tax return, so the deadline is April 15. (More later on what to do if you’ve been living on the wrong side of the law for years.)
Who owes the tax?
When you hire someone to work around the house, you may or may not be considered an employer. The key is whether you control what the worker does. A nanny who cares for a child in your home is almost always your employee. But if she cares for your child in her home, she’s generally not. If you hire your help through a nanny or lawn service, the worker is probably an employee of the service. That means it has the tax headaches.
If you are the employer, though, and you paid $1,400 or more in wages, it falls on your shoulders to pay social security, medicare and unemployment taxes for your worker. Get IRS Publication 926 (Household Employer’s Tax Guide) for the details. Basically, the social security and medicare taxes add up to 15.3% of pay, split evenly between employer and employee. If you didn’t withhold your nanny’s share from her wages and pay the full pop now, covering the worker’s share is considered extra income to her. That, of course, pushes up the wages on which these taxes are due. (Hey, we didn’t say this was easy.) You need to give your nanny a W-2 form reporting her salary (it was due January 31) and send a copy to the Social Security Administration (due February 28).
If you paid your nanny $1,000 or more in any calendar quarter of 2004 or 2003, you also owe federal unemployment tax. It’s ostensibly 6.2% of the first $7,000 of wages, but you’ll get a credit for paying state unemployment taxes that knocks the federal rate down to 0.8%. So it really tops out at $56. (If you’re not square with your state, pay that tax before you file with the feds so that you get the benefit of the credit.) You’ll need a federal-employer ID number to complete your Schedule H. Get it at the IRS Web site or by calling 800-829-4933.
IRS Publication 926 has a handy list of state unemployment offices around the country that you can contact about your state responsibilities. In addition to unemployment taxes, you may owe workers’ compensation or disability insurance. And because those payments are usually due quarterly, you may have already missed deadlines for 2004 and face a late-payment penalty on top of the tax bill.
Amend the sins of the past
But what if you’ve been operating under the radar (and outside of the law) for some time — paying a nanny or other household worker in cash and ignoring the tax rules? What should you do now?
“My advice is to come clean,” says California labor attorney Robert King, who runs Legally Nanny, in Irvine, Cal. For a one-time $595 fee, his firm files the start-up paperwork and shows clients how to comply with federal and state employment and tax rules. Beyond doing the right thing, King offers another reason for paying the nanny tax: “I’ve seen people get caught.” You don’t have to be nominated for a big job, either. King says that household employers get nailed when a former employee applies for unemployment, disability or social security benefits. If you’re snared, you’re on the hook for back taxes — your share and the employee’s — plus interest and penalties.
But how do you come clean?
Tom Ochsenschlager, vice-president of the American Institute of Certified Public Accountants, advises filing amended federal tax returns with the appropriate Schedule H’s attached. Federal returns are open to change for just three years after the due date, so returns for 2000 and earlier years are now closed. Ochsenschlager doesn’t believe taxpayers are obligated to amend returns for closed years, although he says that he once had a client who was being considered for a big federal job who did so. “The IRS cashed the checks,” says Ochsenschlager. You also need to contact state officials to see how to clear up your state records.
At the federal level, you’ll owe interest (the current rate is 5%) plus a late-payment fee of 0.5% per month on the back taxes. State penalties depend on where you live. King says that California slaps a 10% penalty on late employment taxes, plus interest.
Note that paying your nanny taxes may not cost as much as you fear. If your nanny is taking care of your kids so that you can work, payments (including payroll taxes) can be run through a tax-free reimbursement plan at work, or they can earn you the child-care credit.
