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Doing the Right Thing by Paying the

    Nanny Tax

    By RON LIEBER

    Published: January 23, 2009

    The nanny tax issue simply won’t go away.

    The I.R.S. offers guidance for following the tax laws regarding household workers.

    Ever since Zoë Baird, President Bill Clinton’s first nominee for attorney general,

    withdrew her name from consideration because she had broken rules relating to

    household employees, the issue has tripped up public figures every couple of years.

    This week, it became part of the chatter around Caroline Kennedy’s decision to pull out of contention for New York’s vacant United States Senate seat. This month, Timothy F. Geithner’s nomination for Treasury secretary hit a snag over, among other mistakes, an

    issue relating to a housekeeper.

    Every time this happens, it leaves a little pit in the stomach of hundreds of thousands of

    people who are breaking the law themselves. Various estimates put the tax cheat rate at

    80 to 95 percent of people who employ baby sitters, housekeepers and home health aides.

    In 1997, taxpayers filed 310,367 household employee tax payment forms with the

    Internal Revenue Service. By 2006, the latest year for which data are available, the

    number was down to 225,441.

    Given the unease, why don’t household employers pay the taxes and other costs that

    other larger employers do as a matter of course?

    “The chances of getting caught are slim,” said Arthur U. Ellis, president of the Nanny Tax Company in Chicago, which helps clients pay on time. “And why should I pay for something when the vast majority of people are not paying it?” Some employers don’t want to pay the extra 10 percent or so on top of the employee’s

    salary to cover the taxes and other costs. The employees often balk, too, because they

    don’t want taxes withheld from their paychecks. They may demand higher wages to make

    up for money that an employer takes out, raising employer costs even more.

    Perhaps the most daunting part of all of this, however, is how much effort and paperwork

    it takes to do the right thing. Just how complicated is it to comply? Let us count the ways

    in the list below, which I derived in part from I.R.S. Publication 926, the “Household Employer’s Tax Guide.” What follows should serve as a good starting guide for anyone

    who’s finally been scared straight by the news this month.

    1. IMMIGRATION STATUS Employers must make sure an employee is eligible to work

    in the United States. Employees affirm this by filling out a form called the I-9. (I’ve linked to this form and others, which are often in PDF format, in the version of this

    column at nytimes.com/yourmoney.)

    Mr. Geithner got this right, but in an unusual twist, his housekeeper’s authorization to work in the United States expired while he employed her. There isn’t a general

    obligation to regularly check up on an employee’s eligibility, according to David Grunblatt, a lawyer who runs the immigration practice for Proskauer Rose. But

    employers who review a new employee’s authorization document and know that the

    worker’s eligibility will end must review the employee’s status later. 2. EMPLOYER IDENTIFICATION NUMBER You’ll need one of these to put on tax

    forms you file for your household employee. It’s not the same as a Social Security number. You can apply for one on the I.R.S. Web site.

    3. FEDERAL TAXES If you pay $1,700 or more in 2009 to a household employee, then

    you need to withhold and pay Social Security and Medicare taxes. That amounts to 15.3 percent of the worker’s salary, which is generally split equally between employer and

    employee. If you pay more than $1,000 in any quarter to an employee, you must pay

    federal unemployment taxes of another 0.8 percent of wages up to $7,000 a year.

    4. INCOME TAX ISSUES You aren’t required to withhold money for federal, state and

    city income taxes from employees’ paychecks, but they may ask you to do so. Figuring

    out how much to withhold isn’t easy. The paycheck calculator at 4nannytaxes.com can help.

    5. STATE UNEMPLOYMENT TAXES You will probably have to pay them. The I.R.S.

    keeps a list of state unemployment agencies that starts on page 13 of Publication 926.

    Look yours up and seek guidance on the rules.

    6. WORKERS’ COMPENSATION COVERAGE Many states require you to have it, in

    case your employee is injured on the job. You can find a list of the states that do on the Web site of Breedlove & Associates in Austin, Tex., another company that helps people

    pay household employee taxes and handles payroll.

    Getting this wrong can cost serious money. My wife and I struggled mightily to get our

    workers’ comp account set up through the entity that the state of New York forces you to

    use. It didn’t happen until weeks after our baby sitter started working. Not long after, the

    state hit us with a $1,500 fine for our short period of noncompliance, an amount that was

    more than three times the annual premium. We appealed and ultimately paid $250, which

is still insulting given all of our failed attempts to get the agency to return phone calls and

    answer e-mail messages during the application process.

    Kathleen Webb, co-founder of HomeWork Solutions in Sterling, Va., another service for

    household employers, said we were actually lucky. “I’ve seen penalties equal to the price

    of a small car,” she said.

    Your home insurance policy may offer some coverage for household employees, too, so it’s worth a call to check.

    7. FORMS AND PAYMENTS Depending on where you live and your other tax

    obligations, you may have to make quarterly filings and payments to your state for

    unemployment taxes, as well as quarterly filings and payments to the federal government.

    You’ll also have to file Schedule H, the household employment tax form, with your

    federal tax return each April. Miss a deadline, and you could owe penalties and interest.

    8. RECORDKEEPING Given the potential for getting any of this wrong, it’s a good idea to keep copies of every employee pay stub, every form you file and proof of all payments

    from your bank. The I.R.S. suggests keeping records for at least four years after the due

    date of your tax return or the date you actually paid the taxes, whichever is later.

    Exhausted yet? “All of the states and even the federal government make it fairly

    cumbersome for the average family,” said Tom Breedlove, the director of marketing and

    business development at Breedlove. “These are extremely busy professionals, usually

    with small children, and they don’t have an H.R. department and a law team to chase all

    of this paperwork around between 9 and 5 when the government offices are open.”

    Amen, brother. The fact that this is all so hard is a national embarrassment, one that

    infuriates those who labor mightily to comply and causes many more to throw up their

    hands in disgust and flout the tax laws. This costs various governments untold millions in

    lost revenue at a time when they desperately need it. Someone ought to step up and find a

    way to streamline it all.

    Until that happens and I’m not holding my breath — consider a couple of reasons it

    may be wise for people who are not paying their taxes to reconsider.

    Let’s say you have to fire your housekeeper or baby sitter, as an increasing number of

    financially distressed people are doing. The job-seeking nanny may try to file for

    unemployment benefits. If you haven’t paid into the system, you’ll be in for trouble when

    the nanny names the former employer. “The whole house of cards comes down,” said Ms.

    Webb of HomeWork Solutions. “The I.R.S. and the state agencies talk to each other.”

    That means that you could end up owing back taxes, interest and penalties to multiple

    parties.

    Also, consider the human side of this. Household employees who spend their working

    years laboring for employers who don’t pay Social Security or Medicare taxes won’t be

eligible for those benefits come retirement time. Is that any way to repay someone for

    years of service, especially if you’re not paying them enough to put away much money

    on their own?

    If you’re ready to join the ranks of the tax compliant, it will take a dozen or so hours to

    get set up and then a couple dozen more annually to handle all of the paperwork and

    payroll duties. Or, you can hire companies like Breedlove, the Nanny Tax Company or HomeWork Solutions to do it for you. The cost ranges from roughly $400 to $1,300 a

    year, depending on the level of service. A company called NannyPay offers software for do-it-yourselfers for $97.95 a year.

    Once you’re paying on the books, you can use a flexible spending account through your employer to cover up to $5,000 in eligible child or elder care expenses each year. If you don’t have access to such an account, you may also be eligible for the federal Dependent Care Tax Credit.

    The tax savings probably won’t make up for all the costs of following the many rules, especially when you factor in the value of your time. But the good feeling that comes

    from doing the right thing may soothe the financial sting.

    What hoops did you have to jump through to pay by the rules? Send e-mail to

    rlieber@nytimes.com or post a comment at nytimes.com/yourmoney.

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