Beware the 'Nanny Tax'

The IRS is cracking down on wage taxes for more than just nannies, and no one is immune.

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By Mark J. Kohler

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You may think you can pay your landscaper, nanny or maid "under the table" and it's no big deal. They just want cash and don't care, so why not?

After your "worker" leaves, he or she may file for unemployment, apply for student aid to attend college or want to file a tax return to get a loan. All of a sudden, you are tagged by a state or federal agency because you haven't paid the "nanny tax." Now, you need to buckle up for penalties and interest on the amount of tax you should have paid in the first place.

So, how can you prevent tax fraud and save yourself from a load of trouble? Below are the keys you'll need to track and report your household employees before the IRS comes after you.

Related: 75 Items You May Be Able to Deduct From Your Taxes

Don't leave anyone out!

In 2016 or 2017, if you paid a household employee more than $2,000 annually, you are required to withhold payroll taxes: the nanny tax. In these cases, you don't have to issue a formal paycheck every other week unless you want to. You can pay cash and report these payments at the end of the year. But, the IRS is stepping up its audits on those with workers in their private homes, so make sure you are up to speed on the rules that apply to your "help."

Applicable workers:

  • Housekeepers
  • Maids
  • Babysitters
  • Gardeners
  • Any household employee that is not an independent contractor

Exempt workers:

  • Children
  • Parents
  • Spouses
  • Adults under 21
  • Independent contractors

Related: 7 Tax Facts Entrepreneurs Need to Know Before Filing This Year

Paperwork, paperwork, paperwork!

To prevent fraud penalties and keep track of your employees, be sure to keep careful employment records of anyone who works in and around your home. Remember the list from above and try not to leave anyone out when you acquire their information. For starters, be aware of the following forms:

  • W-4 – This verifies the name, address and Social Security number of your worker so you can send them other forms and notices at the end of the year.
  • I-9 – This is to assure your worker is not an illegal immigrant (don't get me started on the legal exposure of hiring an undocumented alien).
  • W-2 – This is issued at the end of the year, due to be delivered to your employee by Jan. 31 of the year following their employment.
  • W-3 – This is a "transmittal form" that you send to the IRS and Social Security Administration with a copy of the W-2 form you delivered to your worker.
  • Schedule H – This is included with your 1040 form and calculates your FICA and FUTA tax that you'll have to send to the feds.
  • State Forms – Don't forget to consider state tax forms you'll need to file; do some research or consult your tax professional for details.

All tax records and forms of household employees should be kept for at least four years after filing.

Related: How to Organize Your Expenses

Give them (the IRS) what they want!

For federal taxes, you'll need to account for both FICA (essentially Social Security and Medicare) and FUTA (unemployment) taxes. For FICA, you can withhold 7.65 percent from your worker's wages and match that percentage when you pay the tax on behalf of the worker. Thus, at the end of the year, you'll report how much you paid the worker and remit 15.3 percent of the total to the IRS with Schedule H on your 1040. FUTA is a simpler calculation as you only need to remit 6 percent of the first $7,000 of wages (maximum $420) to the IRS -- also with Schedule H on your 1040.

Although you may be required to withhold FICA and FUTA, you aren't required to withhold federal income taxes from the employee's pay. You have to withhold only if your nanny asks you to and you agree to withhold. (In that case, have the nanny fill out a Form W-4 and give it to you, so you can withhold the correct amount.) However, you may be required to withhold Social Security and Medicare tax (FICA). And you may also be required to pay (but not withhold) federal unemployment (FUTA) tax.

For state taxes, you may owe some SUTA (state unemployment taxes) or workers' compensation. Check with your tax professional and/or research the regulations in your particular state to see if and when you need to consider these taxes as well.

It's easy to think you don't need to worry about the so-called "nanny tax" or that it doesn't apply to you. And, let's not even talk about what might happen if your worker gets hurt on your property and you haven't been paying workers compensation Insurance. At the very least, use the tools above to track your household employees effectively, report their wages correctly, and withhold and remit the right amounts. Don't ignore the issue -- get ahead of it!

Mark J. Kohler

Entrepreneur Leadership Network VIP

Author, Attorney and CPA

Mark J. Kohler is a CPA, attorney, co-host of the podcasts Main Street Business and Directed IRA Podcast and a senior partner at both the law firm KKOS Lawyers and the accounting firm K&E CPAs. He is also a co-founder of Directed IRA Trust Company. He is the author of The Tax and Legal Playbook, 2nd Edition and The Business Owner's Guide to Financial Freedom.

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