Nanny Tax Must Be Reported on Form 1040

from Ideas for Individuals March 1996 issue

(updated 11/98)

If you have employed a nanny, a housekeeper or other household help, you may have to report federal employment taxes on your federal income tax return. Because lawmakers suspect that many household employers are not paying and reporting these taxes (Social Security, Medicare, unemployment, and income tax withholding) for their domestic help, a Schedule H has been added to the Form 1040. Although the obligation to pay these taxes has existed for years, the introduction of this new schedule presents a dilemma for individual taxpayers with household employees: pay the tax or file an incorrect return.

Do You Have To Complete Schedule H?

The form asks three questions; you must include the schedule in your return if you answer "yes" to any one of them:

Did you pay any one household employee cash wages of $1,000 or more in during the calendar year?
Did you withhold federal income tax during the calendar year for any household employee?
Did you pay total cash wages of $1,000 or more in any calendar quarter of the current year or the preceding year to household employees?

The Taxes Involved Add Up Fast

Social Security and Medicare taxes (FICA) are now 15.3%, and the employer and employee are each responsible for half (i.e., the employer's portion is 7.65%). If the employer pays the employee's portion of these taxes, the additional amount paid by the employer will be taxable income to the employee. Federal unemployment tax (FUTA) is now 6.2% (reduced by any applicable state unemployment tax), all of which must be paid by the employer. An employer is required to withhold a domestic employee's income tax only if they both agree; the amount withheld would depend on the employee's income level and tax bracket.

Reporting Has Gotten Easier

Although Congress is seeking to increase compliance with the employment tax laws, these new procedures are much simpler than the old rules. In prior years, household employers were required to file quarterly tax returns, and until 1994 the threshold for FICA tax was a mere $50 per quarter. Now, instead of quarterly returns, the employer need only complete the one-page schedule and attach it to Form 1040. As in prior years, the employer must obtain a social security number from the employee and an employer identification number (this is different than the employer's social security number), and must complete an annual Form W-2 for each worker. All of the required taxes may be paid when the employer files his or her Form 1040.

What if the domestic employee does not have a work authorization from the Immigration and Naturalization Service? The employer is violating the law by employing someone without verifying his or her ability to work here legally (on Form I-9). However, the employee's status under the immigration laws does not affect the employer's tax liability. Mechanically, if the employee is undocumented, the employer should attach to Form W-2 a signed statement explaining that a social security number, although requested, remains unknown, or can write in "SSA 205(c)" (the provision of law prohibiting undocumented workers from obtaining social security numbers) on the correct line.

Exceptions To The Rule

Finally, there are some important exceptions to the so-called nanny tax in addition to the $1,000 wage thresholds mentioned above. Most important are the exceptions for family members (spouse and children, and in some cases parents) and for persons under 18 who do not do such work as their primary occupation (for example, students). As an example, employment of a full-time high school student as a babysitter would not require payment of FICA taxes even if wages exceeded $1,000 for the year (FUTA would still apply if wages exceeded $1,000 for a calendar quarter).

The burdens of complying with these new rules may seem daunting, and many taxpayers may be concerned about past noncompliance. The IRS has indicated, however, that it does not intend to review past tax years simply because a person begins to file employment tax forms. Moreover, taxpayers who improperly omit Schedule H from their Form 1040 should recall that they may be subject to penalties for filing an improper income tax return in addition to penalties for failure to pay the delinquent taxes. Accordingly, taxpayers should start filing returns for domestic employees.

If you would like further information on this or other issues involving taxation, please contact Kirk H. O'Ferrall or Steven B. Katz of our New York office or any of the other attorneys comprising the Satterlee Stephens Burke & Burke taxation practice at (212) 818-9200.