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You're Not the Only One Who's Not Paying Your 'Nanny Tax'

The Wall Street Journal. logo The Wall Street Journal. 3 days ago
a close up of an umbrella © Ellen Weinstein

A number of prominent Americans have been caught neglecting to pay taxes on their child-care help. They’re not alone.

New research provides evidence of the massive underpayment of “Nanny Taxes” owed by employers and workers on the wages paid to household help such as child- and elder-care providers, maids and drivers.

According to economist Brian Erard, only 5% of 3.6 million American households that should be filing forms and paying federal taxes related to household help are doing so.

This issue famously surfaced in 1993, when Zoe Baird’s nomination by President Bill Clinton to be the first woman U.S. attorney general was derailed by Nanny Tax issues.

More recently, Office of Management and Budget Director Mick Mulvaney said he realized when being vetted for the job that he failed to pay $15,000 in federal taxes and fees for babysitting. He said he was paying what he owed, and was confirmed last year.

Nanny Tax noncompliance is far more common than news stories show. Mr. Erard puts the total federal “tax gap” for domestic workers—i.e. the amount owed but not paid—at between $3.3 billion and $5.7 billion for 2015. Overall, he says, Americans pay less than one-third of Nanny Taxes owed, compared with about 82% of all federal taxes owed, according to IRS estimates.

Compliance may also be falling. In 1995, after the IRS simplified tax filings for employers of domestic help, the number of forms filed was nearly 300,000. In 2016, the latest data available, it was about 181,000.

Mr. Erard’s research, which analyzed data from the Internal Revenue Service, Census Bureau and Labor Department, was funded by the International Nanny Association, an umbrella group representing in-home child-care workers and allied businesses, and presented at a June conference sponsored by the IRS and Tax Policy Center.

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Some domestic workers want to be paid off the books. If so, many will miss out on valuable benefits, such as Social Security disability and old-age payments, the Earned Income Tax Credit, and a health-insurance tax credit.

For employers, complying with the law can be onerous. Still, David Lifson, a certified public accountant at Crowe in New York with many high-net worth clients, insists on compliance. “I tell my clients, ‘You wouldn’t buy an expensive house and not have fire insurance. This is like fire insurance.”

Employers often have far more hassles complying with state than federal rules, he adds. That’s because they can file one form annually for federal taxes, but states often require quarterly reporting and filings to different agencies. Andy Mattson, a CPA with Moss Adams in Campbell, Calif., says his state’s rules are so complex that he requires clients to use a domestic-help payroll service.

One such national service, Care.com HomePay, said it generally charges about $1,000 a year per employer to do federal, state, and local reporting for domestic help.

The IRS hasn’t announced a campaign to spur Nanny-Tax compliance, although it may look harder at this issue given Mr. Erard’s research. Here are details that employers of household help should know.

*Required reporting and payments. The employer reports annual wages paid on Schedule H to the IRS and gives a W-2 form to the employee shortly after year-end.

If the wages were more than $2,100 for 2018, then a 12.4% Social Security tax is due on amounts up to $128,400. Typically this levy is split between the employer and worker, but some employers agree to pay the whole tax.

Medicare tax of 2.9% of wages is also due, typically split between employer and worker. There’s no wage cap. Employers also owe a small federal unemployment tax.

These taxes are paid to the IRS, which sends them on. Income-tax withholding isn’t required for domestic workers.

As noted earlier, state and local authorities have additional requirements.

*Employee vs. independent contractor. Some employers of domestic help say their household workers are contractors responsible for their own work and taxes.

Warning: specialists say this argument almost never holds water, unless the worker is from an agency such as a cleaning or gardening service. The legal standard is complex, but a key element is that the employer has the right to control how the work is done.

*Documented vs. undocumented workers. By one estimate, 22% of household workers are undocumented immigrants.

This is a complex area, and payroll and tax preparers often won’t handle immigration issues. Some states don’t accept taxes from workers without Social Security numbers, says Kerri Swope, an executive with Care.com HomePay.

The IRS accepts payments if the worker has an Individual Tax ID Number (ITIN). It almost never shares such information, and a record of tax payments may be useful in gaining legal status.

Undocumented workers don’t qualify for many tax benefits, but those who become legal can claim credit for past Social Security taxes paid.

*Tax benefits for employers of help. Ms. Swope says that people with access to Flexible Spending Accounts for child care in their own workplace can save up to $2,300 year in federal and state taxes on payments to household help.

Such accounts allow workers to pay child-care expenses with pretax dollars up to $5,000, depending on the plan.

If the taxpayer doesn’t have such a plan, the Child and Dependent Care taxcredit may help. It often reduces taxes up to $600 for one child and $1,200 for two or more.

To receive the tax credit, the taxpayer must provide the name and ID number of the care-giver.

Write to Laura Saunders at laura.saunders@wsj.com

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