According to the IRS, families that pay domestic workers and meet a certain income threshold are considered employers. This has become an issue in the past for public figures that run for office or are appointed to a high-level cabinet position. One of the best-known examples was Zoe Baird, President Bill Clinton’s 1993 nominee for Attorney General.
Once it was learned that her husband had employed undocumented domestic workers and they had never reported it to the IRS, it triggered a scandal known at the time as “nannygate”. President Clinton was eventually forced to withdraw Baird’s nomination, and Janet Reno ended up becoming Attorney General. You and your family may not be as well-off and/or high-profile as a public official, and you may not have a full-time domestic worker. However, this does not mean you are not free from paying the nanny tax. The threshold is so low, that even a seasonal nanny might meet the criteria. For example, if you paid a caregiver over the summer to take care of your child (or children) while out of school, you may very well be in this category.
The threshold for withholding Social Security and Medicare taxes from the pay of a caregiver is only $2,000 per year. If you paid your caregiver $15 per hour, 40 hours per week for just 4 weeks, you have already crossed that threshold. And even if you only paid them $1,000, this is enough to require you to pay state and federal unemployment taxes.
There is some good news in all of this. There are certain individuals that are not considered employees and would generally be exempt from the nanny tax. These include your parents, spouse, other children who are under the age of 21, and a neighbor or friend of the family who is under the age of 18. Anyone outside the family who is over the age of 18, however, is subject to the tax.
What is the Penalty if I Fail to Pay Employment Taxes?
If you decide to ignore the law and not pay employment taxes, it can incur heavy fines from the IRS. Each individual circumstance is different, and it always depends on the amount you owe and how long it has been, but the average offender is subject to penalties and interest of around $25,000. There is also another consequence when you avoid paying the tax; you are shortchanging your employee by not paying Social Security and Medicare. This may cost them down the road when it comes time for them to collect their benefits.
Can I just File a 1099 and Call them a Contract Worker?
The short answer is almost always, no. The IRS makes a fairly clear distinction between an employee and an independent contractor. An employee is one that works for the employer and takes specific direction on how to perform his/her duties. An independent contractor is someone who performs a service for you, but you have no control over the details of how this service is performed. Since parents typically give specific and detailed instructions to nannies about how to care for their children, the IRS considers this an employer-employee relationship. One notable exception is if the nanny is sent to work for you by an outside agency, and you pay the agency a certain rate for her services. Under this arrangement, the nanny is employed by the agency, and they are the ones responsible for her employment taxes.
The nanny tax is a confusing subject, and far more families are subject to it than many people realize. If you employ a domestic worker for even a part of the year and are unsure if this tax applies to you, the best thing to do is speak with a tax professional as soon as possible. A CPA can help answer questions specific to your circumstances and prepare the proper filings (if necessary) to ensure compliance with this tax.