The Nanny Tax

Simpler, Yes
But Still No Stroll Through The Park

On April 15, many individuals were surprised to find they were still required to pay employment taxes on their household help. They were under the impression that Congress “fixed” this unwarranted burden. They were even more surprised to learn that the new system is far from simple.

On October 6, 1994, Congress passed the Social Security Domestic Employment Reform Act of 1994. It reformed the system for paying employment taxes for domestic workers, the so-called “Nanny Tax.” The old system, unchanged since 1950, turned many ordinary citizens into lawbreakers. By the IRS’s own estimate, only 25% of affected households complied with the requirements. Calendar year 1995 was the first full year to which the new law applied.

Under the old rules, Social Security taxes were due and a quarterly return had to be filed whenever a household worker, such as a nanny or housekeeper, earned more than $50 in a quarter. Even a teenager hired as a baby-sitter could trigger Social Security tax liability.

Congress responded to this situation by creating a more “user-friendly” system. The new statute removes many household workers form the Social Security tax rolls, and makes it easier to pay and report taxes for those who remain. However, it does not eliminate the filing requirements for the vast majority of household employees.

Here are the highlights of the reporting requirements as they now exist:

You are required to have an employer identification number and file W-2s on an annual basis if you have a household employee who is paid more than $600 during the calendar year.

You won’t have to pay or deduct Social Security tax for a household worker who earns less than $1,000 during the calendar year. If the worker exceeds the $1,000 minimum during the year, the total earnings during the year (including the first $1,000) are subject to Social Security taxes.

You have to pay FUTA taxes if, during any quarter of the current or preceding year, you paid total wages to all household employees of $1,000. For example, if you paid $400 to a housekeeper and $600 to a nanny during the second quarter, you would be subject to FUTA taxes, even if neither individual received $1,000 of wages during 1995.

For 1995 and beyond, you won’t pay any Social Security tax for most household workers under age 18.

You are not required to withhold income taxes from your household employees unless they request it and you agree to it.

You report your federal employment taxes on an annual basis. These taxes are reported on Schedule H, which is part of your Form 1040, Individual Income Tax Return.

For 1995 through 1997, you can pay the federal employment taxes in a lump sum when you file your annual return. After 1997, the taxes will have to be paid through estimated tax or increased withholding from your own wages.

You are required to inform household employees of the availability of the Advanced Earned Income Credit. You can satisfy this requirement by providing them with Notice 797.

If the household employee is subject to Social Security tax, employers often pay the Social Security tax on their behalf. If you do so, the payment is added to the employee's taxable wages but is exempt from Social Security wages.

Each state has its own rules for payroll taxes and household help. They rarely correspond to the federal rules.