Why paying your nanny under the table is a really bad idea

Don’t even think about making that hush-hush cash payment to your child’s nanny.

On average, families in the U.S. pay child care workers $556 each week — nearly $29,000 a year, according to Care.com. More than half of families report spending at least 10 percent of their household income on child care.

Though it’s easy to agree on a payment schedule with your nanny and hand him or her the cash, you’re risking a reprisal from the Internal Revenue Service. In extreme cases, you face the possibility of prison time.

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You might remember the so-called Nannygate controversy back in the 1990s surrounding President Bill Clinton’s picks for attorney general, Zoe Baird and Judge Kimba M. Wood. Both women came under fire for the way they hired and paid their child care helpers. Baird, in particular, failed to pay Social Security taxes for her child’s care provider and her driver. Neither one got the attorney general job.

“If you’re paying someone to provide you with services, they have to report it as taxable income,” said Tim Steffen, director of financial planning at Robert W. Baird, a wealth management firm.

“If you don’t pay Social Security and Medicare taxes for your employees, you’re subject to penalties and fines,” he said. “It can be considered a felony if you don’t pay and this can lead to prison time if it’s egregious.”

Employee or contractor?

Over the last 10 years, the IRS has received fewer returns showing employment taxes withheld for child care providers, cooks and other home workers.

Taxpayers must submit Schedule H if they paid at least $2,000 in wages annually to a household employee and withheld payroll taxes, including Social Security and Medicare levies, as well as federal income taxes. You’re also required to turn in this form if you paid wages of at least $1,000 in any quarter to all household employees.

You’ll also need to send this worker a W-2 with earnings, tax and withholding details, and you’ll have to send a W-3 to the Social Security Administration.

The deadline to send workers a W-2 for the 2016 tax year was Jan. 31.

Employment status is key: You’re subject to these withholding and reporting requirements if your child care provider is your employee. That is, you control the work this person performs and how it’s done, according to the IRS.

Be upfront

Since willful failure to pay employment taxes can be punishable withtime behind bars, it’s imperative that you knock out the appropriate paperwork before you hire a household employee.

Get on the same page with your household worker in the interview process: Tell the prospective hire that the income will be reported to the IRS.

“Nannies are accustomed to being paid under the table,” said Susan Allen, senior manager for tax practice and ethics at the American Institute of Certified Public Accountants. “Explain that ‘This costs me more each year because I’m paying your extra share of Social Security taxes.'”

Expect those responsibilities to inflate your costs by up to 15 percent, versus paying your nanny off the books, Allen said.

You’ll also need to register with your state as an employer, said Steffen.

File your forms

Here’s what you need to get right with your employee and the IRS:

  • Form I-9: This is used for verifying the identity and employment authorization of your worker. Your employee will need to provide documentation to prove their identity.
  • Form W-4: A withholding allowance certificate that you’ll need from your employee if you withhold federal income taxes.
  • Schedule H: You’ll turn in this form with your 1040 when you file your taxes. This will spell out how much you paid your employee(s) and the applicable unemployment, Social Security and Medicare taxes paid.

It’s also a good idea to have an employment contract with your employee so that you can address issues such as sick days, vacation time and other details.

“I want people to go into it with the full knowledge and transparency of how this relationship works,” said Allen, who herself has hired nannies to care for her children. “Don’t go into this casually.”

Get professional help if you need it

Don’t go it alone. You can hire an accountant to ensure you’re operating on the right side of the law.

Some payroll software providers also offer a home employee option that will allow you to withhold taxes and pay your nanny via direct deposit. Providers include HomePay, Intuit Payroll and NannyPay.

“You’re managing a person,” said Allen. “This has its rewards and challenges.”

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