Employing a nanny is expensive. After the family's mortgage payment, the nanny's salary is often the biggest expense in the household. Add the cost of taxes on top of this and many families wonder "Why?" They reason that not paying the taxes lets the nanny keep more money and saves them 10% on taxes. The nanny makes little enough anyway - why should she have to pay tax?
Reporting nanny wages and paying Social Security taxes is the law. It is also the right thing to do for your nanny. Think about it. When you and your nanny agree to pay 'off the books' you are mutually agreeing to break the law. Is that the way you want your employment relationship with your nanny to start out? What message does that send her?
Risks of Nanny Tax Avoidance...
Both the nanny and the family risk penalties if caught not paying the nanny taxes.
The family has both civil and possible criminal penalties. The family that does not declare the wages of their nanny on their personal tax return runs the risk, if caught, of tax fraud charges. It is rare that the IRS pursues the criminal case; they generally stop once the nanny taxes have been paid. The penalties and interest can easily double the tax due in just 4 - 5 years! If criminal penalties are pursued and the family is convicted, this is a felony offense. It will follow the parents for the rest of their lives.
Nannies, failure to report your income to the IRS annually is a felony offense. The family often 'gets honest' at some point, and the nanny finds a very unexpected W-2 form in the mail. She then must file or amend a previously filed tax return and pay the associated back income tax, penalties and interest.
More Information on Penalties and Interest
The Rewards...
The benefits to the nanny and the nanny's employer in paying the 'nanny taxes' generally fall into two categories.
Tangible Benefits:
- The nanny accrues credits for future Social Security and Medicare benefits.
- Nanny has verifiable income, needed for loan and mortgage applications, utility applications, etc.
- The nanny can document residency and qualify for in-state college tuition rates.
- The nanny qualifies for future unemployment benefits. Nannies often find they need these benefits to tide them over between jobs.
- The family can qualify for child care tax breaks, which often offset some or all of the additional employment taxes.
Risks Avoided:
- Household employment taxes are part of the family's personal Federal Income Tax return. Reporting the wages and paying the tax avoids the risk of failing an audit and the associated financial costs.
- Compliant families will not be caught when the nanny files for unemployment benefits when the job ends. This is by far the most common way a family is caught.
- Protection from Worker's Compensation claims. The family cannot obtain Worker's Compensation Insurance unless they have registered and obtained a Federal Employer Identification Number. The liability here to the family in the event of a work related injury is HUGE!
- There is no statue of limitations for employment taxes. A nanny may file for Social Security or Social Security Disability benefits many years later. When the employment history is not found, it is in the nanny's best interest at that time to report the families she worked for and qualify for benefits. The families will then have to reconstruct the employment history and pay BOTH the employer and employee portions of the non-paid Social Security and Medicare taxes, with substantial penalties and interest and fees to an accountant to figure the whole mess out.