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August 24, 2008 - I am returning to work and will be hiring a nanny for my children. Can you explain what the Nanny Tax is? How do I know if I am subject to this tax?

“Nanny Tax” isn't limited to a nanny. It also applies to a housekeeper, maid, baby-sitter, gardener, private nurses, health aides or similar domestic employees. A household employee is someone you pay to do domestic work as an "employee" rather than an "independent contractor".

If you employ someone who's subject to the “Nanny Tax,” you only have to withhold federal income taxes if your nanny asks you to and you agree to withhold. However, you may be required to withhold social security and Medicare tax (FICA). You may also be required to pay federal unemployment (FUTA) tax.

FICA: You have to withhold and pay FICA taxes if your nanny earns cash wages of $1,600 or more during the calendar year 2008. If you reach the threshold, the entire wages will be subject to FICA. However, if your nanny is under age 18 and child care isn't her principal occupation, you don't have to withhold FICA taxes. You should withhold from the start if you expect to meet the annual threshold.

Both an employer and a nanny have an obligation to pay FICA taxes. As an employer, you are responsible for withholding your nanny's share of FICA. In addition, you must pay a matching amount for your share of the taxes. The FICA tax is divided between social security and Medicare. The social security tax rate is 6.2% each for both an employer and a nanny. The Medicare tax is 1.45% each for both an employer and a nanny.

FUTA: You also have an obligation to pay FUTA taxes if you pay a total of $1,000 or more in cash wages, excluding the value of food and lodging, to your nanny in any calendar quarter. The FUTA tax (at a maximum rate of 6.2%) applies to the first $7,000 of wages paid. You pay the FUTA, so don't withhold FUTA from the nanny's wages.

Reporting and paying: You don't have to file any separate employment tax returns. Instead, you just report the employment taxes on your tax return, Form 1040, Schedule H. You must include your employer identification number (EIN). The EIN isn't the same number as your social security number. If you need an EIN, you must file Form SS-4 to get one.

You must provide your nanny with a Form W-2 by Jan. 31, 2009 if her 2008 wages are subject to any withholding. Additionally, you must file a Form W-2 with the Social Security Administration by Feb. 29, 2009. Your EIN must be included on the Form W-2.

Recordkeeping: Keep careful employment records for each domestic employee. Keep the tax records for at least four years. Records should include: employee name, address, social security number; dates of employment; dates and amount of wages paid; dates and amounts of withheld FICA or income taxes; amount of FICA taxes paid by you on behalf of your nanny; dates and amounts of any deposits of FICA, FUTA or income taxes; and copies of all forms filed.

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