There are about half a million nanny tax filers in the U.S., and most common estimates are that there are about three million employers of household workers who should be filing.
That's quite a gap in compliance with the law. Are Americans such a lot of wholesale tax cheats? I don't think so. Maybe what they need is the FAQs ma'am, just the FAQs.
After the original "nannygate" incidents (remember Kimba Wood and Zoe Baird and their failed cabinet appointments?) the federal government in 1994 tried to make the nanny tax simpler.
They raised the wage threshold, changed reporting from quarterly to annual, and moved nanny tax reporting to Schedule H of the taxpayer's individual income tax return.
The paradox is that statistics show that instead of increasing compliance, the 'simplification' was followed by a drop of over 30% in the number of Americans filing nanny taxes.
What's going on here?
Well, for starters, not one of the U.S. states followed suit, so now nanny taxpayers have to report under two very different systems. For federal nanny taxes they report annually on their Form 1040, Schedule H, but for their own state usually they must follow the traditional quarterly payroll reporting, separate from their personal income tax returns.
It would be difficult to argue with the contention that the nanny tax is far too complicated for private taxpayers. Before writing a paycheck, the household employer calculates various deductions, some of which are based on percentages and some on deduction tables.
It's especially burdensome if the household employer is paying a different wage each paycheck, making them drag out the deduction tables and calculators every payday. Even in cases where the employer is paying the same gross wage each pay period so they don't have to recalculate each time, there are still several maximums to watch out for.
Add to that the nuisance of filing quarterly state payroll tax returns, and in some cases the requirement to pay the taxes quarterly or more rarely monthly, and you may very well have the explanation for the paradox.
The paradox of decreased compliance following the federal 'simplification' of the nanny tax is even greater when you consider that moving the nanny tax onto the taxpayer's individual income tax return actually raised the risks associated with non-compliance.
Now that the federal nanny tax is part of the Form 1040, the taxpayer's personal income tax return is placed at risk. Failing to report and pay required nanny taxes is tax fraud. Normally, where no tax fraud is involved, your individual income tax return may go off limits for assessment after three years, and goes completely off limits after ten years.
Even if you made a major error on your return, the IRS cannot open your return after ten years. But where tax fraud is involved, there is no time limit. So those two or three million non-complying household employers are keeping their federal income tax returns open for audit essentially forever. YIKES, to put it mildly!
While we wait for the tax authorities to truly simplify nanny payroll taxation (are you holding your breath?) let's briefly look at three main issues regarding compliance: good citizenship, social equity, and financial risk.
Of course, it's less expensive not to pay taxes than to pay taxes. If your employer didn't deduct or pay taxes on your salary, s/he could pay you less and save on employer taxes on top of it. It's no different for household employers, except that more of them break the law.
If they hire and pay "under-the-table" they generally pay lower salaries since the worker is evading income taxes, and they also save the cost of payroll taxes levied on the employer, such as Social Security, Medicare, and Unemployment Taxes.
How quickly would we jump to condemn a business owner who increased profits by not paying payroll taxes, or one who did not report workers' wages so as to be able to pay lower salaries? And if the business owner plead hardship or financial necessity as the reason for not paying payroll taxes, how sympathetic would we be?
Of course, it's much easier to be sympathetic to the financial hardships of parents desperate to find good childcare, or adult children desperate to find good eldercare for their aging parents. But unless they have already given up that cool new car, the annual vacation, the evenings out on the town, then maybe legal tax obligation is not the first place where they should be cutting expenses.
As with any kind of tax fraud, good citizens who pay their taxes are the victims of those who evade their tax obligations.
But there are other victims of non-compliance with the nanny tax laws. Think about your own situation.
If you were being paid your salary "under-the-table" would you be glad to be evading taxes?
Would you welcome not being covered by insurance for disability and workplace injuries?
If you lost your job, and found you could not collect unemployment compensation, would you feel advantaged?
Would you ever need to prove your income for a car loan, for rental housing, or for a mortgage?
Is there any possibility that you would ever need the social security system for yourself at retirement, or for your family in case of your death or disability?
We do our social fabric no good by creating an underclass of workers who fall outside of our normal financial systems.
How likely is it that the majority of these marginalized household workers are immigrants, minorities, or others who for one reason or another are at a disadvantage in the marketplace?
Neither U.S. federal nor state tax authorities are currently aggressive in pursuit of nanny tax evaders, though that may change.
Discovery has come about from complaints of disgruntled workers, as a consequence of injury on the job, or an application for unemployment compensation, and even years later when a former worker applies for social security.
A household employer doesn't have to be nominated for a cabinet post to get caught, and when they do get caught they face liability not only for the employer taxes, but also for the employee's portion of the taxes plus stiff penalties and interest compounded over time.
There are various ways to reduce the nanny tax nuisance to manageable proportions. In our next article titled "Nanny Tax FAQs" we'll answer some frequently asked questions, help you figure out if you are subject to the nanny tax, and if so, what you can do about it.
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