Are You Properly Reporting and Paying Your Nanny, Housekeeper, or Babysitter?

Many dentists may hire a nanny, housekeeper, maid, babysitter, or other household worker to assist with the day-to-day activities of the family.  Yet, many of those same dentists are unaware of the federal and state tax payment and filing requirements for those same domestic  workers. As tax enforcement increases both domestically and internationally, those dentists that fail to comply with the so called “Nanny Tax,” discussed below may find themselves under scrutiny by the Internal Revenue Service, or other state and local taxing authorities.

Who does this Nanny Tax apply to and when?

The Nanny Tax is not limited to nannies. It also applies to housekeepers, maids, babysitters, gardeners, or other household workers. Second, any dentist that pays a domestic worker over the threshold of $1,900 (2014) within a calendar year is required to meet certain employment tax obligations discussed below.

Nardone Limited Comment: Even if the domestic worker does not meet the wage threshold, the employer is still required to adhere to certain federal and state labor laws, which will be discussed in a later article. The federal and state labor laws should not be overlooked.

There is a common misconception that household workers can be labeled as independent contractors so that payroll taxes may be avoided. The IRS has ruled that the vast majority of domestic workers should be classified as employees—rather than independent contractors—because the family has the right to control how, what, when, or by whom the work should be performed. It does not matter how many hours they work, how much they are paid, or what they are called.

There is an additional misconception among dentists that the dentist can include their domestic workers on their dental practice’s payroll. Although it may seem like a convenient way to comply with payroll and tax requirements, and even may benefit the dental practice, this is generally not permitted. For payments to represent allowable deductions for the dentist’s dental practice, the payments must represent ordinary and necessary business expenses. From the IRS’ perspective, the expenses must directly contribute to the success of the dental practice. And, because the household workers do not directly benefit the dental practice, the expenses related to the domestic workers do not represent ordinary and necessary business expenses.

What are the General Filing and Payment Requirements?

Once we determine that the dentist has a domestic worker that is subject to the Nanny Tax, we have some basic responsibilities:

1. Withhold Social Security and Medicare taxes from the employee’s paycheck (or pay it on their behalf) as well as all required state taxes. In 2014, Social Security tax is applied to the first $117,000 of wages, but Medicare tax is uncapped. Dentists are not required to withhold income taxes from the domestic worker’s pay, although it is strongly recommended that they do so to help the domestic worker avoid underpayment penalties.

2. Dentists can expect to pay employer taxes in the range of 10 percent to 12 percent of their employee’s gross wages. Specifically, 7.65 percent is paid in the form of PICA taxes (6.2 percent Social Security tax plus 1.45 percent Medicare tax) and the remainder for federal and state unemployment insurance. Just like employee withholdings, some states have small additional taxes dentists may have to pay for their domestic workers.

3. As a household employer, the dentist also has a legal obligation to verify that the domestic worker is permitted to work in the United States. Specifically, the Department of Homeland Security asks each household employer to utilize Form 1-9, which verifies the identity and employment eligibility of all workers. This form does not have to be filed with the U.S. Citizenship and Immigration Services, but it must be kept in the employer’s records for either three years after the employee begins work or one year after the employee is terminated, whichever date is longer.6 Hiring or continuing to employ someone that is not allowed to work in the United States can carry a fine of to $3,200 for each worker.

More Specifics on Filing and Paying Requirements 

Both an employer and a nanny have an obligation to pay FICA taxes. As an employer, you are responsible for withholding your nanny’s share of FICA. In addition, you must pay a matching amount for your share of the taxes. The FICA tax is divided between social security and Medicare. The social security tax rate is 6.2{c91082aefe0e580fe546c40af534787b48cfd474f8c9ab8dac50bf49a7a1c43a} for the employer and 6.2{c91082aefe0e580fe546c40af534787b48cfd474f8c9ab8dac50bf49a7a1c43a} for the nanny, for a total rate of 12.4{c91082aefe0e580fe546c40af534787b48cfd474f8c9ab8dac50bf49a7a1c43a}. The Medicare tax is 1.45{c91082aefe0e580fe546c40af534787b48cfd474f8c9ab8dac50bf49a7a1c43a} each for both the employer and the nanny, for a total rate of 2.9{c91082aefe0e580fe546c40af534787b48cfd474f8c9ab8dac50bf49a7a1c43a}.

Example: In 2014, you pay your nanny $300 a week, and no income tax withholding is required. You must withhold a total of $22.95, consisting of $18.60 for your nanny’s share of social security tax ($300 x 6.2{c91082aefe0e580fe546c40af534787b48cfd474f8c9ab8dac50bf49a7a1c43a}) and $4.35 ($300 x 1.45{c91082aefe0e580fe546c40af534787b48cfd474f8c9ab8dac50bf49a7a1c43a}) for your nanny’s share of Medicare tax. You would pay the nanny a net of $277.05 ($300 – $22.95). For your (employer’s) portion, you must also pay $22.95 ($300 x 7.65{c91082aefe0e580fe546c40af534787b48cfd474f8c9ab8dac50bf49a7a1c43a}), for total taxes of $45.90.

You also have an obligation to pay FUTA tax if you pay a total of $1,000 or more in cash wages (excluding the value of food and lodging) to your nanny in any calendar quarter or the current year or last year. The FUTA tax applies to the first $7,000 of wages paid. The maximum FUTA tax rate is 6.0{c91082aefe0e580fe546c40af534787b48cfd474f8c9ab8dac50bf49a7a1c43a}, but credits reduce this rate to 0.6{c91082aefe0e580fe546c40af534787b48cfd474f8c9ab8dac50bf49a7a1c43a} in most cases. FUTA tax is paid only by the employer, not by the employee, so don’t withhold FUTA from the nanny’s wages.

Reporting and paying: You must satisfy your Nanny Tax obligations by increasing your quarterly estimated tax payments or increasing your withholding from your wages, rather than making an annual lump-sum payment. As an employer of a nanny, you do not have to file any of the normal employment tax returns, even if you are required to withhold or pay tax (unless you own your own business, see below). Instead, you just report the employment taxes on your tax return, Form 1040, Schedule H.

On your income tax return, you must include your employer identification number (EIN) when you report the employment taxes for your nanny. The EIN isn’t the same number as your social security number. If you already have an EIN from a previous nanny, you may use that number. If you need an EIN, you must file Form SS-4 to get one. But, if you own a business as a sole proprietor, you must include the taxes for your nanny on the FICA and FUTA forms (940 and 941) that you file for your business. And you use the EIN from your sole proprietorship to report the taxes for your nanny.

You also required to provide your nanny with a Form W-2. If her 2014 wages are subject to FICA or income tax withholding, the W-2 is due by Feb. 2, 2015. Additionally, you must file a Form W-2 for 2013 with the Social Security Administration by March 2, 2015. Your EIN must be included on the Form W-2.

About the Author

Columbus, Ohio Tax Attorney Vince Nardone is the managing member of Nardone Limited. Mr. Nardone represents professional practices, including dental practices, in business and tax planning matters. Such representation includes: entity selection, professional license and disciplinary actions, business succession, practice acquisitions, and associate buy-ins.

Mr. Nardone also spends a significant portion of his time representing individuals and businesses in federal, state, and local civil and criminal tax controversy matters. This representation extends from the initial audit and examination conducted by the taxing authorities to the administrative appeals process, court review, and collection matters. He has an expertise in handling matters with the Internal Revenue Service, the Ohio Department of Taxation, and other state taxing authorities within Ohio and nationwide.