Research suggests 3.6 million American households are required to pay household employment taxes, yet only 5.3 percent of household employers do1. Colloquially referred to as “nanny taxes,” these taxes aren’t just for nannies—and not complying can result in serious consequences for both the employer and employee.
If you hire someone to help around the house, e.g., housekeeper, gardener, driver, cook, nanny, or caretaker, there are some things you should know about being a household employer. You must follow payroll tax rules and will be responsible for employment taxes. The federal taxes are reported on Schedule H included with your Form 1040, U.S. Individual Income Tax Return. There are other state and federal reporting requirements, many of which require registration. Read below for guidance to help you avoid the household employment tax trap and what can happen if you don’t. (Hint: Getting caught may be easier than you think.)
- Determine if you have a household employee. If you hire someone to do work around your house and you can control what and how the work is done, then you have a household employee. If the worker can control how the work is done, brings his or her own tools, and offers services to the general public, then the individual may be self-employed and not your employee.
- Confirm your employee is eligible to work in the United States. You and your employee should complete U.S. Citizenship and Immigration Services Form I-9, Employment Eligibility Verification, before work begins. Your employee must provide one or two documents (depending on available documents) supporting their authorization to work in the United States. You can keep copies of documents and Form I-9 for your records. You will not submit this form to the IRS or any other agency but are required to have it available if requested. You can verify employment eligibility at e-verify.gov. You also can verify the employee’s name matches the Social Security number (SSN) on the Social Security Number Verification Service webpage.
- Obtain an Employer Identification Number (EIN). The IRS requires household employers to have an EIN rather than using their SSN. You may apply online at irs.gov/EIN to receive an EIN immediately, or you can mail/fax Form SS-4, Application for Employer Identification Number, to the IRS. You will use this EIN to pay employment taxes and file employment forms. Once you have an EIN, you can keep it for as long as needed even if your employees change.
- Calculate employment taxes. If you pay any one employee cash wages of $2,300 or more in 2021 (threshold subject to change each year), then you need to pay employee and employer Social Security and Medicare taxes for a total of 15.3 percent of wages paid. The employee’s share is 50 percent, or 7.65 percent, and you can choose to withhold the employee’s share from the wages you pay or elect to pay the employee’s share. If you pay this amount for your employee, you will include the amount in wages for income tax (but not Social Security or Medicare wages) on the Form W-2, Wage and Tax Statement.
There are some wage payments not subject to Social Security and Medicare tax. These payments include payments to your spouse, child under age 21, parent (in most cases), or any employee under age 18.
While you are not required to withhold federal income tax, you may if your employee requests it and you agree. You should request a completed Form W-4, Employee’s Withholding Certificate.
- Pay employment taxes. All federal taxes will be paid with your Form 1040 by reporting on Schedule H. To avoid owing tax on your return (and potential underpayment penalties), you can increase your federal income tax withholding on your wages or increase estimated tax payments. Consult with your tax advisor for guidance.
- Pay unemployment taxes. If you pay cash wages of $1,000 or more in any quarter (2021), you must pay federal unemployment tax with Form 1040, Schedule H. It is possible you also may owe state unemployment taxes. Consult with your tax advisor regarding state unemployment tax requirements.
- Maintain good records. You can certainly keep track of simple cash wages and taxes and deadlines manually, but you may want to consider using software or online services if you are feeling overwhelmed. A payroll service can help you track hours, wages, and taxes and prepare required year-end Form W-2 and Schedule H for your Form 1040. See the IRS’ Outsourcing Payroll Duties webpage for things to consider if you choose to outsource your payroll duties.
What Happens if I Don’t Pay Household Employment Taxes?
You may recall the infamous “Nannygate” scandal in 1993, when Zoë Baird lost her nomination to become the first female Attorney General of the United States after it was revealed she didn’t pay her household employees’ Social Security taxes. Since then, numerous public figures have fallen from grace in similar situations.
Public officials aren’t the only ones penalized for their failure to pay. Not paying household employment taxes can result in costly penalties and interest, and even felony charges for tax evasion. Many professions require strict adherence to lawful payment of these taxes, and failure to do so could result in the loss of one’s license to practice.
Just because you aren’t audited by the IRS doesn’t mean you can’t get caught. Many noncomplying taxpayers are exposed when their household worker later tries to apply for unemployment benefits. Others are caught when their employee is injured on the job without workers’ compensation insurance. The IRS also may find noncompliance issues when, unbeknownst to the employer, the household worker files his or her own income taxes or tries to sign up for other governmental benefits, e.g., disability, Medicare, or Social Security.
In addition to legal and professional consequences, failure to file household employment taxes is a significant disservice to employees. Without proof of income, workers are denied access to certain loans, mortgages, and rental opportunities. A lack of verifiable wages makes it nearly impossible to build credit and plan for one’s future.
Households looking to hire help have certain responsibilities to federal and state authorities, as well as to their employees. Knowledge is power, and it is helpful to understand your potential responsibilities before hiring an employee.
The above best practices are an excellent starting point to help you avoid costly repercussions. If you need assistance, reach out to your BKD Trusted Advisor™ or submit the Contact Us form below. You also can visit our Outsourced Accounting Services page to learn how we assist with payroll process consulting or check out BKD Private Client™ to learn about our services for high-net-worth individuals.
1 Brian Erard, “Who Is Minding the Nanny Tax?↩