The Nanny Tax

For working families it is nearly impossible to care for children without additional help of a hired caregiver, like a nanny. Some families pay their nanny “under the table,” which is not legal and can be costly. When families fail to pay what many refer to as the “Nanny Tax,” fines and penalties can cost them significantly — up to $25,000. However, the process of properly calculating, filing, and paying payroll taxes can be confusing for the average person. To address this issue, services have appeared, known as Nanny Tax services, to consistently and accurately document and pay a nanny or other domestic service providers.

There are several advantages of using a Nanny Tax service. You will not only protect yourself as an employer from potential penalties, but you will also ensure that your nanny receives short and long-term benefits (e.g., Social Security and Medicare) upon retirement and unemployment benefits for when you no longer need full-time care. This also provides a verifiable employment history and the possibility of reduced health care via the Affordable Care Act.

To learn more about the Nanny Tax, I spoke to mom entrepreneur Nikki Kristol, the founder and managing Partner at My Home Payroll, www.myhomepayroll.com.

Shnieka Johnson: What are the steps to legally hire a nanny?

Nikki Kristol: Step one would be to consider hiring a nanny tax professional to do your home payroll. The steps to legally hire a nanny are very involved and time-consuming. If you are determined to do-it-yourself, there is a lot to do.

Step 2: Track your nanny’s hours, gross pay, withholdings, and net pay. With a log of her hours, and the total amount paid, your filing obligations are easier to determine. There are several paycheck calculators online. However, these tools alone will not help determine what your filing obligations are, what filing deadlines apply to your situation, and any other employer issues, such as Workers’ Comp., Disability, benefits, sick pay, and paid rest.

Step 3. Apply for a Federal Employer Identification Number (EIN).

Step 4. Ask your nanny to complete form W-4 and form I-9, a soon as possible. Form I-9 is your record that she is legally able to work in the United States. Form W-4 is used to determine how much should be withheld from the nanny’s check each pay period.

Step 5. Register with your state as an employer. For New York, look for Form NYS 100. Form NYS 100 is for businesses and household employers to apply for an Employer Registration Number, to ensure that quarterly tax remittances are credited promptly and accurately.

Step 6. Fill out a state New Hire Report for your nanny. This will alert state agencies that you have a new employee. Simply Google: “New Hire for State (X),” and you will find the reporting instructions. For New York, the website is www.nynewhire.com.

Step 7. Check to see if Workers’ Compensation is required in your state. I do this for clients as soon as possible. The penalties for not having adequate workers’ comp are usually more punitive and immediate than failure to pay nanny taxes. For example, in New York State, if your nanny works less than 40 hours a week, and does not live in your home, you are not required to carry Workers’ Compensation Insurance for the employee. However, if the nanny does meet those thresholds, the employer is liable for a penalty of $2,000 per 10-day period of noncompliance.

SJ: Are there certain qualifications or rules to abide by?

NK: A good nanny tax payroll service should have someone who is well versed in the Domestic Employer Laws of your state. In New York, that means the New York State Domestic Workers’ Bill of Rights, Days of Paid Rest, and the city’s Paid Sick Leave Law.

SJ: What are the benefits to the nanny?

NK: Immediately, your nanny is able to show proof of income. Without this proof, how will your nanny rent a better apartment, be approved for a mortgage, or get a new car loan? In the short term, she may be eligible for the earned income credit. Being paid on the books could mean access to better healthcare under the Affordable Care Act. She could draw unemployment once her charges are school-aged, and her services are no longer needed. In the long term, she contributes to Social Security and Medicare, which she will need to draw from at retirement age.

She also establishes a legitimate work history. It means a lot to employers to know you were trusted with small children for a number of years. You are a stronger employment reference for your nanny.

The nanny profession needs to be elevated somehow. What we have is a reputable profession that is usually paid in a disreputable manner (i.e., off the books).

Today’s money-grab for the nanny comes at a cost tomorrow. The nanny may one day realize she is working very hard at a job that offers no benefits in the long term. She may become resentful of that, but so accustomed to not paying the tax, and therefore unable to change the situation. I like to work with nannies that know from the start they want to be paid on the books, and won’t accept anything less. These nannies are usually happy with their work, and are treated as professionals.

SJ: What are the benefits to the employer?

NK: A benefit to clients of My Home Payroll is that we pay your nanny by direct debit, and we file your nanny taxes automatically. Our clients have the added benefit of no paperwork and no running to the ATM on Fridays to withdraw cash for the nanny.

Avoiding the nanny tax can expose you to back taxes, interest and penalties. For some parent-employers, it could mean sanctions, or the loss of a professional qualification.

As a mom, I feel that I have a unique perspective on household employment, and how to pay for it properly. I believe paying off the books taints the relationship you have with your nanny from day one. Because you don’t set boundaries in terms of pay, you don’t create a professional relationship to take seriously. You place yourself in “cahoots” with your nanny from the start. The nanny may see you as a rule-breaker. The nanny may, in turn, expect you to turn a blind-eye to her occasional rule-breaking. Is this the kind of environment you want your child to live in?

SJ: Does the “Nanny Tax” only apply to nannies?

NK: No, the nanny tax applies to anyone who can be considered a household employee. It includes any housekeeper, yard-worker, driver, sitter, private nurse, domestic worker, caregiver, etc., where you determine what work they do and how it has to be done. Your nanny is your household employee, regardless if she works part-time or full-time. Your household employees are to receive a W-2, not a form 1099, at the end of the year.

SJ: Why is it important for families to hire a “Nanny Tax” professional?

NK: Many working families simply do not have time and tax knowledge to be their own payroll service. Paying the nanny tax means paperwork, filings, and record keeping. If there is a problem with the record keeping or the payments, the employer may have to speak to, and correspond with taxing authorities, and other government agencies. It is time consuming. Knowledgeable tax professional will be able to help the family pay nanny taxes seamlessly, and handle all of the extras.

SJ: Are there tax credits that every parent should be familiar with?

NK: Yes. Every parent should know about the Dependent Care FSA, and the Child or Dependent Care Tax Credit.

The Dependent Care Flexible Spending Account is a benefit offered by your employer. It allows the parent to set aside up to $5,000 of pre-tax dollars to pay for child care. Check with your HR department to see if your employer offers an FSA.

Child and Dependent Care Tax Credit, this “Child Tax Credit” is available to taxpayers who both are full-time students, work outside of the home, or are looking for work, and have to pay for child care. The Tax Credit is a dollar-for-dollar reduction in tax liability of $600 or $1,200, depending if you have one or more children. Apply for this credit on Form 2441 and attach it to your yearly tax return form 1040.

Shnieka Johnson is an education consultant and freelance writer. She is based in Manhattan where she resides with her husband and son. Contact her via her website: www.shniekajohnson.com.