Surveys conducted in the United States show that more than 2.3 million household employees are working today. The IRS, on the other hand, reports that only approximately 240,000 household employers use the IRS Schedule H form. What does this mean? It means that most household employers prefer to avoid paperwork by paying their nannies and housekeepers in cash, under the table.

This is fine for everyone involved–until you are caught.

Find out in this section the step-by-step way to manage your nanny’s payroll and taxes.

The Issue with Under the Table Payments

Before moving on to payroll and taxes, let’s address the issues potentially involved with paying cash under the table. It’s a simple process and you certainly avoid lifting as much as a single piece of paperwork. However, if you get caught in this illegal activity, there are serious repercussions.

Say, for example, that one day your nanny goes to collect unemployment. When she files her paperwork the system will show that you, her former employer, never filed unemployment taxes. Look out. This can spiral into a tremendous mess. Not only is your nanny without unemployment compensation, but you are busted and will have to pay back taxes plus all fines. What follows are the repercussions you must consider with off the books payments: 

• Increased exposure in an IRS audit
• Penalties for failure to comply range from $25,000-$100,000 (plus potential jail time)
• Fraudulent statements and/or failure to provide tax statements may result in a $1000 fine
• Payment of all back taxes, interest and penalties
• No eligibility for tax breaks, Dependent Care Assistance, or Child Tax Credit

Your Responsibility as an Employer

You really need to understand the federal, state and local employment laws that pertain to your household and your nanny. Likewise, it’s imperative to be aware of the risks associated with noncompliance. The problem is that depending on your location, you may have plenty of requirements to meet and a slew of paperwork to obtain, file and submit. Dealing with taxes and payroll can be annoyingly time consuming, nerve racking and complicated. Some households prefer to hire outside organizations to handle all matters of nanny payroll and taxes. There is security and peace of mind in knowing that professionals can handle the details.

As an employer, if you should choose to pay your nanny under the table–then good luck to you.

For those household employers who prefer to use a payroll system, what follows is a crash course outlining the regulations pertaining to nanny payroll and taxes.

Understanding the Basic Laws

In a nutshell, ignorance is no longer a respectable excuse for breaking the law. If you have household help working in your home and earning more than $1,500 a year, then you are required to understand and abide by the laws as outlined below.

• Employee vs. Independent Contractor: Determine if your household employment is independent contractor or employee based. Most in-home employees are just that -employees. With this in mind, employees of your home must be accurately paid according to labor and tax laws.
• Tax Laws: The IRS states that a household employee earning $1,500 a year or more in gross wages must comply with all state and federal laws.
• Payroll Regulations: The Fair Labor Standards Act states that household employees must be paid at least the federal or state minimum wage, whichever is higher.
• Employer Responsibilities: As an employer it is the law to report and pay payroll taxes. In doing so, you are complying with payroll tax requirements for your nanny (such as Social Security, Medicare and unemployment insurance). Employers are not obligated to withhold federal and state income taxes unless the employer and employee agree to it.

Obtaining Paperwork

It’s important to obtain the necessary paperwork when hiring your nanny which includes several federal and state forms. To properly pay an employee in accordance with laws and regulations set forth in your jurisdiction, you must obtain the following:

• Form SS-4 Employer Identification Number
• Form W-4 Employee’s Withholding Allowance Certificate
• Form I-9 Employment Eligibility Verification
• Form W-10 Dependent Care Provider’s Identification and Certification
• Form W-5 Earned Income Credit Advance Payment Certificate
• Form 1040 Schedule H Household Employment Taxes
• Form 1040ES Estimated Tax for Individuals
• Registration form for a state unemployment identification number
• Registration form for a state withholding number (if applicable)
• State’s new hire report (if necessary)

Except for the SS-4 form (which is for employer identification), you must first obtain your employee’s social security number. Do not ever assume your chosen nanny has one. In this day and age, it is questionable as to if your prospective employee is actually a U.S. citizen. This can lead to quite a different situation where paperwork and applications are required (which may ultimately play a tremendous role behind the reasoning why many household employers often choose to gamble and pay their employees under the table rather than on the books).

Proper Use of Obtained Forms

• SS-4 or Employee Identification Number (EIN): All employers must have an employee identification number. This is typically the first document you will need to complete which ultimately provides you with a tax number for use in dealing with the IRS and other parties.
• Form W-4: If you and your nanny agree to withhold taxes, then you should retain a copy of the W-4 for your nanny’s use, as she will need to complete it at tax time.
• Form I-9: You will need to have your nanny fill out pertinent information on this form, to ensure that only people legally authorized to work in the United States are hired (Considering the rapidly escalating issue of illegal immigration and changing policies with regard to this matter, it is of particular importance that you keep this document on file along with proper identification copies).
• Form W-10: This is an optional form that taxpayers use for obtaining information about dependent care providers.
• Form W-5: The Earned Income Credit Advance Payment Certificate allows employees to claim earned income credit. Your nanny can receive this credit with her pay during the year. You are encouraged to let her know about this credit if you are paying total wages for the year are less than $33,995.
• Schedule H: Household Employment Taxes, or Schedule H, is a form to use along with the Federal Form 1040 for employers who pay more than $1,500 during the calendar year. This document will allow you to report wages and taxes withheld for household help to the federal government along with your 1040 form.
• Form 1040 -ES: This document allows you to make estimated tax payment to cover employment taxes for your nanny. Essentially, this voucher will allow you to make payments and pay all of your employment taxes at one time or in an installment plan. This form must be procured on a quarterly basis.

Federal Taxes

Payroll taxes are federal taxes that must be paid by employers to ensure your household nanny is protected in the event she is no longer employed, for whatever reason, and must seek new work. In a sense, this is a type of “insurance” for your nanny so she will be protected and covered due to unexplained separation from employment. There are two options for filing federal payroll taxes, annually or quarterly. Remember that you will report and file your federal taxes using the Schedule H, which is an annual form used to report to the IRS all wages paid to your nanny throughout the year. If you so choose, you may also elect to pay your taxes on a quarterly basis using an estimation method. In order to do this, you will need to file the 1040-ES which calculates an estimate of your employee’s federal income tax, Social Security and Medicare, as well as unemployment tax.

State Taxes

Many states require quarterly filing of state taxes (state unemployment and other taxes). After you have registered with your state to comply with state regulations, the state will then send you quarterly forms with instructions for filing. Upon registering with your state, you will be sent information with regard to parameters involving filing frequency.

Social Security

Paying into Social Security is an important benefit to your nanny, because it provides retirement coverage to your nanny when she becomes older. Providing this valuable benefit for your nanny is important because it shows that your respect her position in your home as well as her future.

Medicare

Just like Social Security, Medicare requires your nanny and your household to pay, equally. This tax is 2.9% of the nanny’s gross salary, so both parties will end up paying 1.45%. There is no salary limit earned for this tax. As noted above, Medicare is just as an important benefit as Social Security. Essentially, Medicare is providing for your nanny’s future when she is older and retired. Medicare provides basic medical insurance for the aged when they may need it most.

Worker’s Compensation and Disability Insurance

Most states require employers to carry worker’s compensation or a disability policy if employing full or part-time help. If you do not cover yourself and an employee injury occurs in your household, you could set yourself up for possibly a very costly lawsuit if your nanny is injured on the job. It is important to note that homeowner’s insurance policies do not often cover these situations. With this coverage you will be protecting yourself and your home and protecting your nanny’s health and well-being in the process.

Record Retention

It is vital to keep all of your nanny’s records in an employee file in a safe place. This includes all interview information, nanny job description, tax, IRS forms, state forms and payroll documentation. Particularly with immigration issues and the like, it is recommended that these forms be kept on file for at least five-years, in case the IRS or Department of Justice needs to check who is, or has been, employed in your home.