In a Tough Economy, Families Ignore the Nanny Tax at their Peril

Internal Revenue Service data for the period 1996 - 2006 indicate that nanny tax filings had dropped 26%. With total nanny tax filings of 225,441 in 2006 and an estimated 1.2 million nannies, voluntary nanny tax compliance is in the 20% range. According to a Wall Street Journal report, "growth in online hiring, and the casual, cost-averse attitudes of parents who find their nannies on the Web" are the primary causes for the poor compliance figures.

In a tough economy, nannies often find their jobs disappear when one of the parents looses their job or faces a significant drop in income. These nannies were happy to be paid "under the table" in cash when times were good. However, faced with a difficult job market, many of these same nannies will find their way to the unemployment office to file for benefits to tide them over between jobs.

This is when the laws of unintended consequences come into play.

The financial risk to the family in these cases is significant. The family has the obligation for remittance of the payroll taxes, not the nanny. A nanny who was being paid $400 cash has little or no income tax obligation on her wage - her risks for coming forward are nominal, and insignificant in the face of her lost earnings and need for unemployment benefits. The family, however, has approximately a $3700 back tax bill for just one year - and that is before penalties, interest, and the cost for professional assistance amending previously filed income tax returns. Consider for a minute that in metro areas the nanny cash wage is often $500 - $600 a week or more and the liability grows substantially.

There is no statue of limitations on payroll taxes - two or three years of back nanny taxes can quickly add up to the price of a small car.

It is true that nanny tax avoidance is the norm. The IRS has made no effort to enforce this tax in the last decade. A bad economy and the suddenly unemployed nanny, however, will bring the whole house of cards down quickly. Is this a risk that you are comfortable with?

More information about the risks of nanny tax avoidance can be found in 4nannytaxes.com's FAQ.

Paying Nanny Under the Table - Potentially an Expensive Experience

Many families - 70 - 80% according to IRS estimates - choose to pay their nanny under the table. This 'saves' the family the approximately 10% premium on employment taxes, and maximizes the nanny's take home since she does not make the Social Security, Medicare, and income tax contributions that other US wage earners do.

Sounds like these families have found a money saving proposition, right? The true answer is maybe, and maybe not!

Nanny positions are, by their nature, not permanent positions. The children will grow, move on to preschool, kindergarten, elementary school. The family's child care needs change dramatically from full time, to part time, to after school or before school only. The full time nanny typically will have to move on after a few years, as they cannot live on the reduced income.

Nanny positions do not always end pleasantly - a family that suffers a job loss, for example, may dismiss the nanny without notice because they don't have the current income to support the nanny. Nanny may not live up to the family's standards and be similarly dismissed without notice or severance. Our 15 years of experience indicates that nanny job loss almost inevitably results in a trip to the local unemployment office and an application for benefits to tide the nanny over until the next job - irrespective of whether taxes were paid or not! Guess what? Nanny can receive these benefits even when you didn't report her income.

The Los Angeles Daily News recently interviewed accountants and tax experts and came to the same conclusion. California accountant Eva Rosenberg shared the experience of a client who fired their nanny, only to have the nanny file for unemployment benefits. The state assessed the family back taxes, penalties, interest and reported the family to the IRS.

"Since no payroll tax returns had ever been filed, there is no statute of limitations," Rosenberg said. "They can go back forever. It could be nasty."

Parents commonly cite two overriding reasons for their tax evasion - the expense and the paperwork.

Many parents do not realize that the expense can be offset - often entirely - by available tax incentives. A dependent care account, funded to the maximum $5000 annually, can reduce a family's tax burden by $2000 or more - offsetting the employment taxes on the first $20K they pay the nanny annually! If a dependent care account is not offered by one of the parent's employers, they can look to the Child Care Credit and a possible $1200 tax break. These tax incentives are not available to families who pay their nanny under the table!

There are solutions for the nanny tax paperwork readily available. For about $1 a day, families can outsource their nanny tax compliance paperwork to a firm like HomeWork Solutions Inc., a national nanny tax services company offering their services to families for 15 years. Full payroll and tax compliance services are as little as $2 per day! Peace of mind does not come with an expensive price tag!

Do you want to learn more about nanny tax compliance and 'getting right' with the IRS? Call 1-800-NaniTax (626.4829) and talk to Marcia or one of our other nanny tax specialists. They will be happy to walk you through your options and get you started down the road to nanny tax compliance.

January Nanny Tax Deadlines Fast Approaching...

Do you have a nanny caring for your child? January is when the rubber hits the road for nanny employers (ditto for housekeepers, maids and other household staff) vis a vis the nanny taxes.

Your nanny or other household staff are due a 2007 Form W-2 Wage and Tax Statement no later than January 31. This is a multi-part form, with several copies for your employee, a copy for the Social Security Administration, and possibly a copy for your state.

Your state unemployment taxes are due by month end in most circumstances (check your forms, some deadlines are different).

Did you deduct state income taxes from your worker's payroll? You not only have to make your end of year payment to the state this month, but most likely also have to provide an annual reconciliation statement with a copy of your W-2 form(s) by the end of the month.

Payment of your federal nanny taxes is reconciled on Form 1040 Schedule H - an attachment to your personal federal income tax return. This effectively adds your nanny taxes to your personal income tax obligation. You need to report and pay these taxes to qualify for your child care credit or to claim funds in your dependent care account.

Thinking of skipping the nanny tax? Think again. You sign your personal income tax return under penalties of perjury. Historically, in times of federal budget deficits and declining revenues (heard the term recession lately?) the IRS steps up collection efforts. A two income family with dependent children without claimed child care expenses may very well be painting a red bulls-eye target on their income tax return!

You can learn more about the risks and penalties of nanny tax non-compliance at the 4nannytaxes.com website.

Why should you pay the 'Nanny Taxes'?

Approximately 1.5 million American families fail to pay their Nanny Taxes, cheating their nannies and housekeepers of retirement and unemployment benefits. This number has steadily increased over the last decade, despite Congress' efforts and the fact that these families commit perjury on their family tax returns every year.

Prosecution for failure to file and pay the nanny taxes is rare. Why should you pay the nanny taxes anyway?

1. Statue of Limitations? There is NO statue of limitations for failure to pay federal employment taxes. The family who fails to collect and pay the federal employment taxes becomes responsible for BOTH the family and the employee contributions if challenged at a later date. We recently assisted a widow's estate with a $95K employment tax nightmare - when grandma passed on, her former housekeeper of 18 years filed for Social Security Benefits, only to find that no earnings had been reported for close to 2 decades.


2. Nanny taxes as a weapon in a divorce - really! Seeking to improve her property and maintenance settlement, a wife threatened to turn over her soon-to-be-exes income tax returns to his law firm demonstrating that he didn't pay his nanny taxes! Tax fraud routinely results in disbarment. The attorney engaged us to assist with filing 3 years of amended tax returns to remove the threat.


3. Whoa! Your housekeeper was injured on the job and requires medical care. Your homeowner's insurance does not cover your employees - that is what you need worker's compensation insurance for. You can only obtain this coverage when you are paying the nanny or housekeeper legally. Without the proper insurance, the family will be held liable for medical costs, rehabilitation costs and lost wages. Sadly, we speak to at least one family a year facing thousands of dollars in nanny medical expenses they never even considered. By the time the accident occurs, it is too late to get the insurance coverage.


4. Valuable tax credits! Your nanny's payroll and associated taxes may be used to qualify for special tax treatments afforded to child care expenses. The positive benefit of these tax breaks can often completely off-set the family's expense for tax compliance.


5. Your nanny is likely to file for unemployment benefits when the relationship ends. This is the most common way families get 'caught' cheating on the nanny taxes. The nanny needs these benefits to tide her over until she finds another job. In the case of the live in nanny who is let go, her need is even more dire. She won't think twice about filing for these benefits and the possible consequences to her former employer.

I have provided nanny tax compliance services for 15 years. I assure you, in every one of the client profile situations above the family really thought that not paying the nanny taxes was not a big deal - until it came back to haunt them.