Over the past 20 years, media reports have highlighted instances in which a public figure has run afoul of the law for not properly paying what is commonly referred to as a nanny tax. These FICA taxes were coined the nanny tax because early cases tended to involve a public figure not paying appropriate payroll taxes for a nanny. Even though you may have heard reference to this type of tax made with some frequency in the past couple of decades, you may wonder what a nanny-related tax is all about.
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Basic Definition of Nanny Tax
In the United States, this type of tax relates specifically to taxes that need to be withheld from household employees, as well as the money paid by an employer to the Internal Revenue Service and, in some cases, a state taxing authority. The federal tax liability is know as FICA taxes. Examples of household employees, sometimes referred to as “domestic staff” or “domestic workers” include:
When a Household Employee Payroll Tax is Required
The U.S. Internal Revenue Code or IRC establishes specific parameters under which a payroll tax on a nanny or other household worker must be paid. As of 2019, if a household employee earns more than $2,100 during the course of a year, the employer must withhold FICA taxes from an employee and make an employer contribution as well.
In addition to this tax liability, a person with a household employee may also be required to pay federal unemployment insurance taxes. This obligation accrues as a household pays any number of workers $1,000 or more during any quarter in a calendar year. In addition, an obligation to pay state unemployment insurance taxes occurs when this threshold is met, with three exceptions: In California the obligation kicks in at $750, in New York at $500, and in Washington, D.C. at $500.
Understanding the Distinction Between Employer Versus Independent Contractor
In the United states, people who work in a private home are nearly always classified as employees. These workers are typically required to follow the directions, timelines, and work parameters that are set by the owners. Providing a nanny or some other domestic worker a 1099 as an independent contractor is not legally proper.The IRS has made this type of misclassification a major enforcement priority. Hundreds of thousands of taxpayers have been identified and sanctioned for this type of misclassification in the past five years. The IRS intends to maintain this as a top enforcement priority going forward into the future.
Domestic service workers who are improperly treated as an independent contractor pay their own employment taxes. They lose the safety nets of unemployment compensation and/or workers compensation insurance when the job ends or if they suffer a workplace injury
The costs for failing to pay FICA and unemployment insurance taxes for household employees can be significant. A person who fails to pay the nanny tax can face the prospect of paying accrued interest as well as penalties.