hile most CPAs are aware of the need to file payroll reports for household employees, clients may not fully understand the risks of not reporting wages paid to household workers.
A taxpayer who paid a household employee more than $1,400 in cash wages in 2003 most likely owes the nanny tax. Even if annual compensation is expected to be less than the threshold for withholding, tax should be withheld—the employer can later refund the withheld taxes if the worker does not meet the filing threshold.
The EIC is treated as a tax payment; any excess over the employee’s tax liability is refunded. Refundable credits can be significant and provide quite an incentive for an employee to report wages on form 1040.
Employers may face the following additional costs in this situation:
FICA tax. Normally, an employer pays half (7.65%) of FICA and withholds the other half from the employee’s wages, under IRC sections 3101(a) and (b) and 3111(a) and (b). However, if no taxes were withheld, the employer is liable for the entire 15.3%.
FUTA. Under section 3306(b) an employer generally pays FUTA on the first $7,000 of an employee’s annual wages, at a rate that can be as high as 6.2% of taxable wages.
State unemployment taxes. These rates vary depending on the state and the employer. Also, the state most likely will assess interest and penalties for late filing.
Underpayment penalties. FICA and FUTA are reported on an employer’s personal income tax return and deemed part of the employer’s personal income taxes. Thus, if the employer’s taxes were underpaid because employment taxes were omitted, the IRS may assess underpayment penalties and interest.
Form W-2 penalties. An employer’s failure to timely file an employee’s form W-2 each year may result in a per-form penalty up to $50, under section 6722.
For more information see the Tax Clinic, edited by Stefan Gottschalk, in the February 2004 issue of The Tax Adviser.
—Lesli Laffie, editor