What could happen if I don’t pay the nanny taxes? Are there any good reasons to pay?
In-home care is expensive. After the family’s mortgage payment, the nanny or home health aide salary is often the biggest expense in the household. Add the cost of taxes on top of this and many families wonder “Why?” If I don’t pay the taxes the nanny keeps more money and it costs me less. 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?
Paying your nanny under the table can incur serious legal consequences. Both the nanny and the family face penalties if caught not paying the nanny taxes.
Risks for the Family
The family has both civil and possible criminal penalties.
- Charges for tax fraud: Once a family has filed a personal income tax return that failed to report nanny wages, they run the risk of criminal tax fraud charges. Following the nanny tax law can protect families from these charges. The Internal Revenue Service (IRS) rarely pursues the criminal case — they generally stop once a family pays the nanny taxes due.
- Nanny tax penalty and fines: On top of the nanny tax, once the IRS discovers tax fraud, they also charge families fines and penalties on top of the FICA and federal unemployment taxes due. The state where the family lives will also require failure-to-file and failure-to-pay penalties for state unemployment tax. These penalties and interest can easily double the tax due in just 4-5 years!
- Criminal charges: If criminal penalties are pursued, and the family is convicted, this is a felony. Former NYC Police Commissioner Bernard Kerik was jailed for tax fraud, including nanny tax fraud. A felony conviction will follow the parents for the rest of their lives.
- Lack of Workers’ Compensation Insurance: Only employees registered with the IRS can obtain a policy of insurance that protects the family from the financial consequences of a workplace accident. An uninsured workplace accident can ruin a family financially.
- Unemployment Insurance Claim: The most frequent way a family gets “caught” is when the relationship ends on bad terms. Another way is if the nanny has difficulty finding a new job and files for unemployment insurance. Most states have joint enforcement agreements with the IRS. As soon as the nanny files her claim with no record of unemployment taxes paid, the IRS and possibly the state Department of Labor are automatically notified so they can take their own enforcement actions.
Risks for the Nanny
Your nanny faces similar criminal and civil penalties if they fail to report their income. Failure to report your income annually to the IRS 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 pertaining to a past tax year. The Nanny must file an accurate tax return or amend a previously filed tax return and then pay the associated back income taxes and penalties with interest.
» How Does the IRS Calculate Penalties and Interest?
The benefits to the nanny and the employer in paying nanny taxes generally fall into two categories.
Paying many taxes benefits the nanny financially and opens new possibilities for her, including:
- Accrual of credits for future benefits: Paying FICA taxes (Social Security and Medicare) means the worker can receive retirement benefits once they qualify. These benefits help cover the cost of health care and living expenses for the disabled or those over 65 years old. When families report their nanny’s income, they let them benefit from Social Security and Medicare later on.
- Verifiable income: Every worker, including nannies, needs verifiable proof of income for loan and mortgage applications, utility applications, and establishing personal credit. Try opening a cell phone account or getting an apartment lease without verifiable income!
- Documented residence for in-state college tuition rates: Many nannies relocate to a particular area because their long-term goals involve attending a particular college. Obtaining resident status with a verifiable income makes them eligible for substantial tuition cost breaks as well as qualifying them for financial assistance.
- Future unemployment benefits: Nannies often find they need these benefits to tide them over between jobs. A nanny’s job will end, as children grow up and a family‘s needs change.
- Refundable tax credits: The Earned Income Tax Credit is a credit available to certain low-income wage earners. This can be several hundred to several thousand extra dollars in the nanny’s pocket every year.
Following the nanny tax law also benefits the family by qualifying them for child care tax breaks. The child care tax credit is a tax break for families that pay for child care assistance to enable them to work, attend school, or search for a job. The maximum work-related expenses eligible for this tax credit are $8,000 for one child and $16,000 for two or more children.
Depending on the household income, the family can write off up to 50% of these child care expenses. These tax breaks can offset some or all of the additional employment taxes. Families must meet a few requirements to claim the credit:
- The family’s children must be younger than 13 years old when the nanny is caring for them.The family’s annual household income must be less than the income limit of $438,000 to receive the credit.
- Families must identify the person who cares for their child or children using their taxpayer identification number, name, and address.
- The family must also accurately report their work-related expenses, including the cost of child care, to ensure they receive the appropriate amount of credit.
- Since most nannies qualify as household employees, the family would also have to pay taxes for Social Security, Medicare, and federal unemployment benefits.
In addition to reaping the benefits of paying your nanny tax, you won’t have to worry about risks like:
- Federal Income Tax return audits: Reporting the nanny’s wages and paying the tax avoids the risk of failing an audit and the associated financial costs. People can lose their jobs for committing this kind of tax fraud. For example, an attorney charged with failure to pay the nanny taxes may be disbarred, and a doctor can lose their license to practice. These are serious consequences that families can easily avoid.
- Discovery through unemployment benefits: This is by far the most common way a family is caught. An unemployed nanny who needs to pay rent or buy groceries is suddenly far less concerned about possible future tax problems.
- Worker’s Compensation claims: The family cannot obtain workers’ compensation and disability insurance for nannies unless they have registered and obtained a Federal Employer Identification Number. The liability to the family in the event of a work-related injury is huge! A nanny or home care worker who throws out their back handling your toddler or assisting your elderly parent can easily accumulate thousands of dollars in medical bills and lost wages. We have encountered dozens of these situations over the years.
- Back taxes: There is no statute of limitations for employment taxes, and 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 they 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 unpaid Social Security and Medicar