The nanny tax.

• Author: Young, Helen

The Social Security Domestic Employment Reform Act of 1994, referred to in the media as the "Nanny Tax," listed the rules on reporting wages and taxes for individuals who hire domestic workers. (See amended Sec. 3121 and new Sec. 3510.) Recently issued Notice 95-18 (written in a question and answer format) gives taxpayers guidance in applying these new rules.

For annual wages of $1,000 or more paid after 1994, household employers are to report and pay FICA, Medicare, FUTA and Federal withholding taxes on an annual basis when filing their Form 1040s. The taxpayer will be required to attach a new Schedule H to his tax return. Withholding of Federal income tax for the domestic employee(s) remains elective. Taxpayers need to be aware that their payroll taxes are due on their return due dates without regard to extensions. Consequently, employment taxes will become an important consideration when completing tax liability calculations for domestic employers who wish to extend the filing date for their individual returns.

Prior to 1995, employers of household employees were required to file quarterly Form 942, Employer's Quarterly Tax Return for Household Employees, to report FICA, Medicare and withheld income taxes. The employer was also required to file Form 940 (or 940-EZ), Employer's Annual Federal Unemployment (FUTA) Tax Return, to report FUTA taxes. All taxes were deposited on a prescribed schedule using Federal deposit coupons (Form 8109) with the employer's bank. Before the 1994 legislation, the threshold for FICA and Medicare tax was $50 per calendar quarter, an amount that clearly placed a severe compliance burden on household employers.

In addition to the annual $1,000 wage threshold, there are several other exemptions to the payroll tax requirements. Individuals who employ (1) workers under the age of 18 whose principal occupation is not domestic service, (2) their spouses, (3) their parents or (4) their own child under the age of 21 are not required to file and pay Social Security and unemployment taxes. It is clear that such exceptions are required to clarify the status of family members and neighborhood teenagers who baby-sit or provide other domestic services for a fee. The employer is required to complete a W-2 for all domestic employees, even if wages are less than $1,000.

A sole proprietor who files Form 941 quarterly and Form 940 annually for business employees can choose to (1) include the employment taxes for household...