Avoiding a ‘nanny’ tax sting

Situation: Your client is considering hiring a nanny to care for his children. With the recent news about cabinet members and tax issues, he wants to know what the rules are.

Solution: Over the years, various cabinet member appointees have been tripped up by such rules. There are things to know to get it right.

First and foremost, know that this rule applies if you pay someone for household work and that that person is your employee. Some workers who can be considered to be doing household work are babysitters, nannies and health care aides.

A person doing this type of work is your employee if you control the work that is done and how it is done. For example, when you hire a nanny and require him or her to report to work at very specific hours in your home, using your own household supplies in the process, that person is your employee.

The Internal Revenue Service closely considers whether a person is an employee or an independent contractor. An independent contractor must show factors that indicate true independence, such as being able to determine when and where work is performed, to work for others and provide their own equipment. An example of a household independent contractor is a gardener who comes to the home as needed or on a flexible schedule.

You also need to make sure the person is eligible to work in the United States. You must verify that the employee is a U.S. citizen or alien who can legally work here. To erase any doubt, ask the person to complete IRS Form I-9, “Employment Eligibility Verification.” Remember that it is unlawful for you to hire or continue to employ an alien who cannot legally work in the United States.

If you pay your household employee $1,700 or more in 2009, you are responsible for the payment of your employee’s share of payroll taxes. You also must pay your own payroll taxes. However, you are not required to withhold federal or state income taxes. You should withhold those taxes only if the household employee asks you to do so. Remember that if you withhold them, you are responsible for paying them to the taxing authorities.
When you file your federal tax return, you will need to include IRS Form 1040, Schedule H, “Household Employment Taxes.” This form will help you compute what taxes are owed. And of course any amount owed is due with the filing of Form 1040 by April 15.

In order to fill out and file a completed Schedule H, you will have to apply for and obtain an employer identification number, which is different than your Social Security number. You will also need to give your employee an IRS Form W-2 so they can file their own tax returns. Therefore, you will need to get their Social Security number so that you can fill out Form W-2 completely.

Even though you might not be considering a political appointment, you are still subject to these rules. For more information, refer to IRS Publication 926, “Household Employer’s Tax Guide.”