Considering Nanny Taxes When Choosing Childcare
You’ve no doubt heard all the buzz about the various “nanny taxes” that employers are required to remit to the government if they happen to employ a nanny or other in-home employee. Although you may be tempted to try to avoid paying these nanny taxes in the hope of trimming your payroll costs — tax experts estimate that playing by the nanny tax rules boosts payroll expenditures by approximately 11 percent — you may want to think twice before making this gamble.
You see, trying to dodge the nanny tax can be very risky business indeed. If you get caught, you may find yourself on the hook for your share of the back taxes, the nanny’s share, plus the usual penalties and interest. You even leave yourself open to criminal prosecution if you knowingly lied on your tax return about the fact that you owed nanny taxes. (Remember that when you sign on the bottom line of your tax return, you’re swearing that your return is true, correct, and complete. If you lie, you’re committing perjury, which is a major federal offense.)
Although some folks argue that the risks of getting caught are virtually nil, they’re being overly optimistic. If your former employee were to apply for unemployment benefits, worker’s compensation benefits, or Social Security benefits even many years after the fact, the IRS could come after you to try to collect any unpaid nanny taxes. (The nanny tax has no three-year statute of limitations on errors or omissions. You’re on the hook, period.)
So simply accept the fact that nanny taxes are part of the cost of hiring a nanny and fork over the necessary cash to the IRS. If nothing else, you’ll sleep better at night knowing that you’re playing by Uncle Sam’s rules.
Here’s the lowdown on the various types of taxes you should know about to stay on Uncle Sam’s good side, namely
- Federal income tax
- Social Security and Medicare
- Federal Unemployment Tax (FUTA)
- State taxes
Obtaining an Employer Identification Number (EIN)
Collecting employment taxes is one of the least fun aspects of being an employer. These taxes are a pain to calculate, a pain to collect, and a pain to remit. Unfortunately, Uncle Sam doesn’t give you a lot of choice in the matter. If you meet certain criteria, you’re required to play tax collector, whether you like it or not.
Of course, before you can report employment taxes or start issuing tax statements to employees, you need to apply for an Employer Identification Number (EIN), which is a nine-digit number that the IRS uses to identify the tax accounts of employers. You can apply for an EIN by mail by completing Form SS-4, or you can apply by phone. (Call your local IRS office or visit the IRS Web site.)
If you haven’t received your EIN by the time your first tax payment is due, you’ll have to make your deposit directly to the IRS. (You won’t be able to make your payment via a financial institution until you receive your EIN.)
Whatever you do, don’t hold off on making your payment until you receive your EIN. The penalties for making late payments are fairly hefty, ranging from 2 percent for deposits that are made one to five days late to 15 percent for accounts that are still unpaid after the IRS has sent you an official notice that your account is past due. (Ouch!)
Federal income tax
Although you aren’t required to withhold income taxes from your nanny’s paychecks, she may want you to anyway to avoid getting hit with a hefty tax bill in the spring. If she asks you to withhold income tax and to remit it to the government on her behalf, you’ll need her to complete and sign a Form W-4: Employee Withholding Allowance Certificate. This form, which summarizes her filing status and how many exemptions she qualifies for, will assist you in calculating how much tax you should withhold from each paycheck.
By the way, you may find yourself having to advance tax money to the nanny if she happens to qualify for the Earned Income Credit (a federal tax credit for low-income workers). If she provides you with a properly completed Form W-5: Earned Income Credit Advance Payment Certificate, you’ll be required to advance her some of this credit on each paycheck.
For more on tax issues, see Publication 926: Household Employer’s Tax Guide, available from any IRS office or from the IRS Web site.
Social Security and Medicare
Social Security taxes fund old-age, survivor, and disability benefits for workers and their families, and the Medicare tax pays for hospital insurance. After the wages you pay your nanny reach a certain threshold determined by the IRS (in 2003, that threshold was $1,400 per year), you’re required to pay both these taxes on your nanny’s wages.
Technically speaking, you and the nanny are responsible for each paying half of the Social Security and Medicare taxes, but many employers choose to cover both the employer and employee portions of these taxes. Because the two taxes amount to 15.3 percent of the total wages, and her share is half this amount, picking up the tab for her half would cost you 7.65 percent of her wages.
Whether you decide to pay the total cost or just your share, you’re the one who’s responsible for ensuring that these taxes get remitted to the IRS.
Federal unemployment tax
The Federal Unemployment Tax Act (FUTA), in conjunction with state unemployment systems, provides compensation to workers who’ve lost their jobs.
The FUTA tax typically amounts to 6.2 percent of your employee’s FUTA wages. However, you are able to take a credit of up to 5.4 percent against the FUTA tax, which brings the net tax down to just 0.8 percent, provided that you paid all your previous year’s state unemployment taxes on time.
Depending on where you live, you may be required to pay both the federal unemployment tax (the FUTA tax) and the state unemployment tax. Or you may only be required to pay one or the other. To find out about the rules in your state, contact your state unemployment tax agency. (Check the government pages of your local phone book.)
Even if you don’t actually have to fork over any cash for any federal taxes, you may still be required to pay taxes for unemployment and workers’ compensation insurance. In most states, you become liable for state employment taxes as soon as your total payroll (for all employees, not just a single employee) exceeds $1,000 per calendar quarter. Of course, this threshold is much lower in some states. It’s just half this amount ($500) in New York and the District of Columbia.