Personal Financial Advisor: The Nanny Tax

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	Babysitter's Rules Personal Finance Advisor by Deloitte & Touche OnLine July 8, 1996

Take care of their taxes as they take care of your children.

Remember Zoe Baird? President Clinton wanted to appoint this bright, talented woman to an important Justice Department post, but her savvy apparently stopped at her front door. Baird never bothered to pay her "nanny taxes," the colloquial name for the widely ignored federal taxes that must be paid by those who employ household workers such as baby-sitters, cleaning help, and gardeners.

The failure by Baird and several subsequent political nominees to pay their nanny taxes cost them coveted political appointments but prompted Congress finally to change the nanny tax requirements, which were widely viewed as overly burdensome, to make it easier for law-abiding citizens to comply with the law.

The reforms passed in 1994 streamlined the employment tax payment process and allow many people to pay these taxes on their personal income tax returns.

If you employ household workers, you generally are responsible for paying two taxes: Social Security and Unemployment. Under the new rules, depending upon how much you pay the worker, you may be fully or only partly responsible for these taxes, or not liable at all.

Here’s a summary of the new rules:

$1,000 Rule: If you pay a domestic worker more than $1,000 per calendar year, those wages are subject to Social Security (FICA) taxes. This $1,000 threshold applies to each worker separately. If you pay your nanny $1,200 and your gardener $500, the nanny’s income is subject to FICA, but the gardener’s is not. The $1,000 threshold will be indexed for inflation beginning in 1996, meaning it will increase to offset the effects of higher prices for goods and services.
Trading: Trading, or bartering, domestic services for something else of value is not subject to FICA taxes, regardless of how much the services traded are worth. For instance, if you provide a guest house in exchange for gardening services, and the guest house has a rental value of $4,000, none of this amount is subject to FICA. Before you rush out and start to negotiate for your gardening services, a few other rules apply. You still have to file a Form W-2 "Wage and Tax Statement" for the worker, the same as if you paid wages. This is because the worker has to pay self-employment taxes on all wages received. You may want to tell this to a worker in advance, instead of surprising them with the statements at the end of the year.
Under Age 18 Exception: Wages paid to a domestic worker under the age of 18 are not subject to FICA taxes, unless that work is their principal occupation. If you employ a high school student to mow your lawn, you do not have Social Security (FICA) responsibility if they are age 17 or under. If the worker is a high school drop-out and working full time as a gardener, you are responsible for their FICA taxes.
FUTA Treated Differently from FICA: The Federal Unemployment Tax Act (FUTA) imposes a 6.2% unemployment tax on the first $7,000 of wages earned by an employee. This tax is put into a fund used to help pay unemployment benefits for people who lose their jobs. FUTA is treated differently from Social Security taxes under the "nanny tax" rules because the $1,000 threshold amount is not per employee, but for all employees. For instance, if you paid your over-18 gardener $600, and your nanny $600, you would not owe FICA tax for either worker, but would owe FUTA tax on the full $1,200.

If you only employ domestic workers, you can pay the required taxes through quarterly estimated tax payments, if you are required to make them, or on your annual return. If you employ other workers in a business or other activity, the unemployment tax must be paid quarterly instead of annually.
Use Schedule H to Pay Nanny Taxes: The IRS introduced a simpler way to pay the so-called "nanny tax" in the 1995 filing season. Household employers can report their payroll taxes on Forms 1040 or 1040A using the new Schedule H, "Household Employment Taxes." Schedule H covers Social Security and Medicare taxes as well as federal unemployment tax and any federal income taxes withheld from the worker.
Other Items of Interest:
- When you hire an employee, make sure they have a Social Security number. If not, have them apply for one on Form SS-5 at the nearest Social Security office.
- If you don’t have an employer identification number, you should get one by filing Form SS-4 at the nearest Social Security office.
- If the worker was hired through an employment agency, you may not be responsible for their employment taxes.

You should check rules in your state to see what separate reporting requirements they may have.

If you determine you have employment tax obligations, sometimes using a payroll service to prepare the necessary payroll tax filings is an inexpensive way of complying and having peace of mind.