General Practice, Solo & Small Firm DivisionMagazine
Seven Steps to "Nanny Tax" Compliance
BY RICHARD M. COLOMBIK AND CARY R. ROSENTHAL
© American Bar Association. All rights reserved. Richard M. Colombik, J.D., C.P.A., is the principal and Cary R. Rosenthal, J.D., is a senior associate in the law firm of Richard M. Colombik & Associates, P.C., with offices in Schaumburg, Northbrook, Oak Brook, Palos, and Chicago, Illinois.
In June 1993, most observers pegged Stephen Breyer as the odds-on favorite for appointment to the Supreme Court seat vacated by Justice Byron White. Amidst reports of Mr. Breyer’s failure to pay Social Security taxes, President Clinton passed over Breyer’s appointment in favor of Ruth Bader Ginsberg.
Breyer, a "brilliant jurist who taught antitrust law at Harvard and reads Proust in French," eliminated his "pesky Zoe Baird problem" by paying the taxes, only to have the IRS determine that he didn’t owe the money after all.1
All’s well that ends well. Stephen Breyer, the dutiful taxpayer, later secured a Supreme Court seat upon Justice Harry Blackman’s retirement. But what happened to Zoe Baird after President Clinton withdrew her attorney general nomination in 1993 due to her failure to pay Social Security taxes on her children’s nanny? She secured the dubious honor of having this particular malady named after her.
Ms. Baird was hardly alone. The IRS estimated that 2 million Americans failed to pay or report the "nanny taxes" for household workers in 1994. The IRS believed that only 25 percent of household workers were in compliance. Experts blamed this failure to comply, in part, on complicated and time-consuming compliance requirements.
Under prior law, household employers filed six to 18 employment and unemployment tax forms annually, depending on where they lived and how much they paid. It was far easier to dispense with the formalities. Household workers did not complain about evading income taxes. Congress designed the Social Security Domestic Reform Act of 1994, signed into law by President Clinton on October 22, 1994, to "decriminalize" high-school baby sitters by raising filing thresholds and eliminating paperwork.2
Some suggest that the new and improved requirements are anything but simple. Any well-read, bilingual, Harvard law professor should be able to follow these seven steps, gleaned mostly from Internal Revenue Service Publication 926, Household Employer’s Tax Guide for Wages Paid in 1998.
Where Do I File?
If an envelope addressed to "Internal Revenue Service Center" came with your tax booklet, please use it. If you do not have one or if you moved during the year, mail your return to the Internal Revenue Service Center for the place where you live. No street address is needed.
Alabama: Memphis, TN 37501-0002
Alaska: Ogden, UT 84201-0002
Arizona: Ogden, UT 84201-0002
Arkansas: Memphis, TN 37501-0002
California (counties of Alpine, Amador, Butte, Calaveras, Colusa, Contra Costa, Del Note, El Dorado, Glenn, Humboldt, Lake, Lassen, Marin, Mendocino, Modoc, Napa, Nevada, Placer, Plumas, Sacramento, San Joaquin, Shasta, Sierra, Sisklyou, Solano, Sonoma, Sutter, Tehama, Trinity, Yolo, and Yuba): Ogden, UT 84201-0002
California (all other counties): Fresno CA 93888-0002
Colorado: Ogden, UT 84201-0002
Connecticut: Andover, MA 05501-0002
Delaware: Philadelphia, PA 19255-0002
District of Columbia: Philadelphia, PA 19255-0002
Florida: Atlanta, GA 39901-0002
Georgia: Atlanta, GA 39901-0002
Hawaii: Fresno, CA 93888-0002
Idaho: Ogden, UT 84201-0002
Illinois: Kansas City, MO 64999-0002
Indiana: Cincinnati, OH 45999-0002
Iowa: Kansas City, MO 64999-0002
Kansas: Austin, TX 73301-0002
Kentucky: Cincinnati, OH 45999-0002
Louisiana: Memphis, TN 37501-0002
Maine: Andover, MA 05501-0002
Maryland: Philadelphia, PA 19255-0002
Massachusetts: Andover, MA 05501-0002
Michigan: Cincinnati, OH 45999-0002
Minnesota: Kansas City, MO 64999-0002
Mississippi: Memphis, TN 37501-0002
Missouri: Kansas City, MO 64999-0002
Montana: Ogden, UT 84201-0002
Nebraska: Ogden, UT 84201-0002
Nevada: Ogden, UT 84201-0002
New Hampshire: Andover, MA 05501-0002
New Jersey: Holtsville, NY 00501-0002
New Mexico: Austin, TX 73301-0002
New York (New York City and counties of Nassau, Rockland, Suffolk, and Westchester): Holtsville, NY 00501-0002
New York (all other counties): Andover, MA 05501-0002
North Carolina: Memphis, TN 37501-0002
North Dakota: Ogden, UT 84201-0002
Ohio: Cincinnati, OH 45999-0002
Oklahoma: Austin, TX 73301-0002
Oregon: Ogden, UT 84201-0002
Pennsylvania: Philadelphia, PA
Rhode Island: Andover, MA 05501-0002
South Carolina: Atlanta, GA 39901-0002
South Dakota: Ogden, UT 84201-0002
Tennessee: Memphis, TN 37501-0002
Texas: Austin, OX 73301-0002
Utah: Ogden, UT 84201-0002
Vermont: Andover, MA 05501-0002
Virginia: Philadelphia, PA 19255-0002
Washington: Ogden, UT 84201-0002
West Virginia: Cincinnati, OH 45999-0002
Wisconsin: Kansas City, MO 64999-0002
Wyoming: Ogden, UT 84201-0002
American Samoa: Philadelphia, PA 19255-0002
Guam (permanent residents): Department of Revenue and Taxation, Government of Guam, P.O. Box 23607, GMF, GU 96921
Guam (nonpermanent residents): Philadelphia, PA 19255-0002
Puerto Rico (or if excluding income under I.R.C. § 933): Philadelphia, PA 19255-0002
Virgin Islands (nonpermanent residents): Philadelphia, PA 19255-0002
Virgin Islands (permanent residents): V.I. Bureau of Internal Revenue, Charlotte Amalie, St. Thomas, Vl 00802
Foreign country (U.S. citizens and those filing Form 2555, Form 2555-EX, or Form 4563): Philadelphia, PA 19255-0002
All Pennsylvania and Foreign Operating Post (FOP) addresses: Philadelphia, PA 19255-0002
Employee or Independent Contractor
Step 1: Determine whether the household worker is an employee or an independent contractor. Household work is work done in and around the home by babysitters, nannies, health aides, private nurses, maids, caretakers, yard workers, and similar domestic workers. A household worker is one hired by the taxpayer to perform household work.
A household worker is a taxpayer’s employee if the taxpayer controls what work is done, and how it is done, regardless of whether the worker works full or part time, was hired through an agency or from a list provided by an agency or association, or whether the worker is paid hourly, daily, weekly, or by the job.
A household worker is self-employed only if the worker controls how the work is done. Self-employed workers usually provide their own tools and offer their services to the general public in an independent business. If an agency provides the worker and controls what work is done and how it is done, then the worker is the agency’s employee and not the taxpayer’s.
If the worker is not an employee, then no further tax compliance is required. If the worker is an employee, the next step is to determine whether that employee may legally work in the United States.
Step 2: Determine whether the employee legally works in the United States. It is unlawful to knowingly hire or continue to employ an alien who cannot legally work in the United States. Household employees must complete the employee portion of Immigration and Naturalization Service (INS) Form I-9, Employment Eligibility Verification. The taxpayer must then verify that the employee is either a U.S. citizen or an alien who may legally work, and complete the employer part of the form. The taxpayer (employer) retains Form I-9.
Paying Employment Taxes
Step 3: Determine whether employment taxes must be paid. If the taxpayer pays cash wages of $1,100 or more in 1998 to any one employee, not including the taxpayer’s spouse, children under the age of 21, parent, or other employee under the age of 18 during the 1998 tax year, then the taxpayer must withhold and pay Social Security and Medicare taxes. The taxes are 15.3 percent of cash wages. The employee’s share is 7.65 percent, and the employer’s matching share is 7.65 percent. The employer (taxpayer) is liable for the employee’s share regardless of whether the taxpayer withholds it from the employee.3
If the taxpayer pays cash wages of $1,000 or more in any calendar quarter of 1997 or 1998 to household employees, not including the taxpayer’s spouse, children under the age of 21, or parents, then the taxpayer must pay federal unemployment tax. The tax is usually 0.8 percent of cash wages. Wages of more than $7,000 a year per employee are not taxed. The taxpayer may also owe state unemployment tax.
If neither Social Security and Medicare nor federal unemployment tax applies, the taxpayer may still need to pay state employment taxes, depending on the particular state.4 Taxpayers who employ household employees are not required to withhold federal income tax from the household employee’s wages.5
If the household employee cares for the taxpayer’s dependent who is under the age of 13, or the taxpayer’s spouse or dependent who is not capable of self-care, and the household employee by his or her services permits the taxpayer to work, then the taxpayer may be able to claim an income tax credit of up to 30 percent of the expenses, including the employer’s share of the federal and state employment taxes.6 This credit is claimed on Form 2441.
Cash wages include wages paid with checks, money orders, and other negotiable instruments. Cash wages do not include the value of food, lodging, clothing, or other noncash items given to household employees. Reimbursement of up to $65 per month for commuting to the taxpayer’s home by public transportation is also excluded from cash wages.
What’s Your Employer Identification Number?
The Tele-TIN numbers listed below will involve a long-distance charge to callers outside of the local calling area and can be used only to apply for an EIN. The numbers may change without notice. Call 800/829-1040 to verify a number or to ask about the status of an application by mail.
Look up the location of your principal business office or legal residence, and call the Tele-TIN number.
Florida, Georgia, South Carolina (770/455-2360)
New Jersey, New York (New York City and counties of Nassau, Rockland, Suffolk, and Westchester) (516/447-4955)
New York (all other counties), Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, Vermont (978/474-9717)
Illinois, Iowa, Minnesota, Missouri, Wisconsin (816/926-5999)
Delaware, District of Columbia, Maryland, Pennsylvania, Virginia (215/516-6999)
Indiana, Kentucky, Michigan, Ohio, West Virginia (606/292-5467)
Kansas, New Mexico, Oklahoma, Texas (512/460-7843)
Alaska, Arizona, California (counties of Alpine, Amador, Butte, Calaveras, Colusa, Contra Costa, Del Norte, Glenn, Humbolt, Lake, Lassen, Marin, Mendocino, Modoc, Napa, Nevada, Placer, Plumas, Sacramento, San Joaquin, Shasta Sierra, Sisiyou, Solano, Sonoma, Sutter, Tahema, Trinity, Yolo, and Yuba) Colorado, Idaho, Montana, Nebraska, Nevada, North Dakota, Oregon, South Dakota, Utah, Washington, Wyoming (801/620-7645)
California (all other counties), Hawaii (209/452-4010)
Alabama, Arkansas, Louisiana, Mississippi North Carolina, Tennessee (901/546-3920)
If you have no legal residence, principal place of business, or principal office or agency in any state (215/516-6999) Paperwork
Step 4: Obtain an employer identification number (EIN) by February 1, 1999. Obtain and fill out Form SS-4, Application for Employer Identification Number. Obtain the telephone number for the taxpayer identification number at the applicable IRS Service Center. This number is in the Form SS-4 instructions. Inquire as to the procedure for obtaining the number. Service Center procedures vary, but each has a fax number and a specific "stop" where you send in Form SS-4 (see "What’s Your Employer Identification Number?").
Step 5: Prepare Form W-2, Wage and Tax Statement. Give the employee Copies B, C, and 2 of Form W-2 by February 1, 1999.
Step 6: Send Copy A of Form W-2 to the Social Security Administration by March 1, 1999. The address for submission is: Social Security Administration, Data Operations Center, Wilkes-Barre, PA 18769-0001.
Step 7: File Schedule H, Household Employment Taxes, with Form 1040 or 1040A, by April 15, 1999. (See "Where Do I File?" for your filing address.) The amount shown on Schedule H is carried over to line 52 of Form 1040.
Taxes are not due until the return is filed. However, the IRS may penalize taxpayers for underwithholding. Underwithholding applies to not only income tax but also the household workers employment and unemployment taxes. Taxpayers may make estimated quarterly income tax payments, or increase withholding from their wages to forestall penalties.
These seven steps pertain only to federal compliance. Various states have their own schemes for withholding taxes and unemployment taxes. Most state taxing authorities are often more difficult to deal with than the IRS. While Congress has eliminated federal quarterly returns for household employees, many states still require quarterly filings. You must check with the state of employment regarding its requirements.
Has This Simplified Scheme Worked?
Perhaps the critics are correct and this new scheme is not so simple. However, it is far easier than filing Form 942 every quarter under the former procedure. Did this new, more user-friendly scheme result in the anticipated increased compliance? If you believe the IRS, the number of people paying the tax actually fell 40 percent! In 1994 almost 500,000 filed Schedule H. In 1995 that number fell to under 300,000. The number increased slightly to 314,000 Schedule H filers in 1996. The IRS believes that as many as 4 million taxpayers now owe nanny taxes each year, which means that fewer than one in 13 taxpayers are in compliance, compared with one in eight taxpayers under the old system.7
One final interesting statistic: since Congress and President Clinton enacted the new, simplified compliance laws, despite the estimated millions of tax evaders, the IRS has only caught two taxpayers with that pesky Zoe Baird problem.8 CL
1. "Zoe Baird" No More. Want to Keep Your Cabinet Nomination on Track? Firm Provides Complete Payroll Services for your Household Help, Chicago Tribune, July 24, 1994, at Business Section, p. 3.
2. New "Nanny Tax" Rules Remove Daunting Hurdles. Law "Decriminalizes" Baby-Sitters, Raise Filing Thresholds and Reduces Paperwork, Chicago Tribune, November 30, 1994, at Your Money Section, p. 3.
3. I.R.C. § 3121(a)(7)(A) excludes from the definition of wages for FICA purposes non-cash payments for domestic service in a private home. Domestic service in a farmhouse is covered by I.R.C. § 3121(g)(5). I.R.C. § 3121(a)(7)(B) excludes from the definition of wages cash payments for domestic service in a private home that total less than the applicable dollar threshold in any calendar year. I.R.C. § 3121(a)(7)(B), as amended by P.L. 103-387. The applicable dollar threshold is defined in I.R.C. § 3121(x). The dollar threshold is adjusted annually for calendar years beginning after 1995. For 1998, the dollar threshold is $1,100. 62 Fed. Reg. 58762(10/30/97). For remuneration paid in 1994 through 1997, the annual dollar threshold was $1,000. Before amendment, the threshold was $50 per calendar quarter. Note that for services performed after 1994, employment does not include domestic service in a private home of an employer performed by an individual who is under age 18 during any portion of the year and that is not the principal occupation of that employee. I.R.C. § 3121(b)(21).
4. Under I.R.C. § 3121(b)(2), FICA taxes do not apply to domestic service performed in a local college club, or a local chapter of a college fraternity or sorority by a student who is enrolled and is regularly attending classes at a school, college, or university. I.R.C. § 3121(b)(2). In addition, remuneration for domestic services in a private home, local college club, or local chapter of a college fraternity or sorority is subject to federal unemployment taxes (FUTA) if the cash remuneration paid to such individuals totals $1,000 or more in any calendar quarter in the current taxable year or in the preceding one. I.R.C. § 3306(c)(2).
5. I.R.C. § 3401(a)(3) exempts from income tax withholding remuneration paid for domestic service in a private home, a local college club, or a local chapter of a college fraternity or sorority. Cf. Rev. Rul. 68-448, 1968-2 C.B. 481 (sorority housemother whose compensation was subject to both FUTA and income tax withholding); and Rev. Rul. 72-174, 1972-1 C.B. 315 (domestic services performed by students for a university women’s club not excepted from employment taxes). I.R.C. § 3402(p).
6. I.R.C. § 21(b)(a)(A). See Regs. § 1.44A-1(b)(i).
7. IRS Finds More People are Skipping Nanny Tax Simplified Rules Bring Increase in Cheating, New York Times News Service, Chicago Tribune, at News p. 15.