The Legal Review by Breedlove and Associates - Employment Taxes

A Complimentary Resource from © 2014 Breedlove & Associates, LLC. Breedlove & Associates

When it comes to taxes, the tiniest of details can be the difference between smooth sailing and a giant headache. With the back-to-school hiring rush in full swing, now is a great time to familiarize yourself with a few household employment details (also known as the "nanny taxes," although the payroll, tax and labor laws apply to all types of domestic workers employed by a family). This particular household employment case highlights how a family's personal income tax return became much more complicated after the wrong tax returns were filed.

The Mistake

The Richmond family hired a nanny last year and utilized a local CPA to handle their tax return filings. The CPA made all the family's quarterly state tax payments on their behalf and prepared their year-end documents, but also made quarterly federal tax payments for the family using Form 941.

The Law

The use of Form 941 is for remitting federal quarterly tax payments for commercial businesses. But household employers are not commercial businesses, and according to IRS Publication 926, they should make estimated tax payments using the federal 1040 Estimated Payment schedule. The only exceptions to this rule are if the family already owns a business as a sole proprietor or if they operate a for-profit farm. These estimated payments cover the Social Security & Medicare (FICA) and federal income taxes withheld from an employee as well as the employer's share of FICA and federal unemployment insurance taxes. The taxes are remitted to the IRS in mid-April, mid-June, mid-September and mid-January using Form 1040-ES.

The Mess

When the Richmond's CPA filed their personal income tax return and Schedule H this year, the IRS showed the family owed additional taxes coincidentally equaling the amount of the taxes they sent in on their 941 returns. The family contacted the IRS and an agent informed them of their error in using Form 941. Unfortunately, the Richmonds were already past the 1st quarter of 2014 when they spoke to the agent and their CPA had filed another Form 941 on their behalf. 

The Outcome

The family ultimately had to file amended 941 returns for all of 2013 and the 1st quarter of 2014 with instructions to transfer those tax payments to their personal taxes using their Social Security number. This allowed the Richmonds to amend their 2013 personal income tax return and get on the 1040 Estimated Payment schedule for the rest of the 2014. While ultimately the family's CPA had all the family's payroll and tax information correct from the beginning, the mistake of filing a Form 941 instead of Form 1040-ES resulted in hours of additional work and a frustrated client. 

Household employment is a highly-nuanced section of the tax code with numerous exceptions and exemptions that don't apply to commercial enterprises. The state and federal complexities, combined with the unique labor law obligations, can create risk for families and liability for their advisors. That's why we were created as a comprehensive "nanny tax" specialist. Founded in 1992, we provide families in all 50 states with an affordable, "no-work, no-worry" solution to household employment payroll, tax and HR obligations.

Quick Tax Facts:

$1,900: Annual wage threshold for Social Security & Medicare (FICA) reporting in 2014

$1,000: Quarterly wage threshold for Unemployment reporting (some state thresholds are lower)

$2,500: Total childcare tax breaks available for families

1.5: Overtime rate of pay when work exceeds 40 hours

$0.56: Federal mileage reimbursement rate in 2014

$7.25: Federal minimum wage (some state rates are higher)

$2: Approximate daily cost to have HomePay by Breedlove handle all payroll and tax compliance duties with no work and no worry.

THE LEGAL REVIEW

The Legal Review

Bringing the Law to Life for the Household Employment Industry

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A Complimentary Resource from © 2009 Breedlove & Associates, LLC.
Breedlove & Associates
In an effort to strengthen your business practices and steer clear of legal trouble, The Legal Review will share findings from relevant legal cases. We've found that the easiest way to gain a practical understanding of complex tax and labor law is by reviewing real-life situations. These stories will illuminate potential legal landmines for your agency and/or your clients, and more importantly, show you how to avoid them.
Felony Tax Evasion -- United States v. Randall & Mary Miller

There is a common perception that the government does little to enforce household employment tax law - and even when they do, the punishment is nothing more than a slap on the wrist.

The truth is that state unemployment agencies and the IRS have become increasingly aggressive about tax collection - and using severe punishment as a deterrent - because the gap between taxes due and taxes collected (known as "the tax gap") has become untenable. While financial penalties are still the norm, this case demonstrates that the government is willing to also levy prison sentences in certain circumstances.

The Mistake

A family paid their nanny "under the table" from 1994 to 2002. After an audit of their personal income taxes in 2003, the Millers pled guilty to one count each of conspiring to defraud the United States by failing to file household employment tax returns.

The Law

An employer is required by law to pay employment taxes to the state and the IRS, in addition to withholding taxes from their employee's pay. Failure to do so is considered felony tax evasion.

The Mess
Once convicted, the Millers were required to make financial restitution (back taxes plus penalties and interest for each of the years PLUS the employee's portion of social security and medicare taxes that should have been withheld). They were given five years of probation, conditioned upon meeting the restitution agreement and future tax obligations.
In December 2006, the probation officer filed a petition to revoke the Millers' supervised release because they had failed to make payments against their restitution agreement and also failed to file their personal tax return for 2005. This revocation meant the Millers would go to prison.
Wanting to avoid prison, the Millers filed an appeal with the Eighth Circuit Court of Appeals. The appellate court upheld the original ruling so Mr. and Mrs. Miller are now serving prison sentences of 14 months and 13 months, respectively.
The Outcome

After years of stressful and time-consuming audits, depositions and court proceedings, the Millers have begun serving their sentences. When they are released from prison in mid-2010, they'll be jobless, heavily-indebted felons. Worse, since they each held a professional license which is revoked upon felony conviction, both will have far less earning potential when they re-enter the workforce. For their children's sake, let's hope they're ultimately able to work themselves out of this financial hole.

How the Whole Thing Could Have Been Avoided

The Millers are similar to many other professional families who employ nannies. Hearing that many people pay their nanny "under the table," they rationalized their non-compliance as a victimless crime - and a necessary evil in order to provide quality care for their children. What makes their situation unique is simply that the amount of tax debt grew to a point where it overwhelmed their ability to pay. The accumulation of nine years of employer tax debt - along with the ensuing legal fees, penalties and interest - literally broke the bank.

Had they paid legally from the beginning of the relationship, the tax costs would have been infinitely more manageable - especially when you factor in the ability to take advantage of tax breaks for childcare expenses. As the Millers have learned (unfortunately, the hard way), paying a nanny illegally is a highly risky decision with potentially devastating consequences.

For more information about household employment tax and labor law,
please visit us at www.breedlove-online.com or call us at 888-BREEDLOVE (273-3356).
We're here to help our agency partners provide their candidates and clients with information, tools and resources that improve the employment relationship, eliminate legal risks for all parties, and generally increase the professionalism of the industry.

TAX TIPS!

MORE FROM BREEDLOVE & ASSOCIATES!

Tax-Time Tips

How to Save Time, Money and Headaches on April 15th

With the income tax deadline rapidly approaching, it's a good time to share a few tax-related tips, reminders and updates - along with some helpful resources for additional information. Investing a few minutes now may help you avoid expensive, time-consuming legal problems.
If you paid a household employee more than $1,600 during the 2008 tax year - or more than $500 during any calendar quarter of 2008 - you may have tax obligations that need to be addressed prior to filing your personal federal tax return. Obligations are complicated and can vary depending on the details of your situation so we won't try to list them all here. If you think you may have obligations, we strongly advise you to talk to a tax and labor law expert who specializes in household employment. As a client of ours, we've arranged a complimentary, no-obligation phone consultation with one of the nation's leading household employment experts, Breedlove & Associates (1-888-273-3356). In about 10 minutes, they can asses your individual situation, run payroll scenarios, help you budget, maximize your tax breaks and generally answer all your questions.

Note: While some families choose to pay their employee "under the table," please understand that this practice is illegal and potentially very expensive. The IRS and the state unemployment office are aggressively enforcing the law with steep penalties (and occasionally even time in prison - a couple was recently sentenced to 14 months after violating the restitution terms of their probation stemming from a felony conviction for household employment tax evasion). Although prison is very rare, please be forewarned that expensive, time-consuming legal problems are becoming increasingly common.

There are tax breaks which can offset - sometimes even exceed - the employer tax obligations, so there is very little financial incentive to take the risk noted above. Those who pay legally have two tax break options: 1) Flexible Spending Account and 2) Child/Dependent Care Tax Credit. For more information about how to maximize your tax breaks, contact Breedlove & Associates (1-888-273-3356; www.breedlove-online.com) or the IRS (1-800-829-4933; www.irs.gov) or a tax professional.

Note: Your income tax return will ask you for a Federal Employer Identification Number (FEIN) in order to take advantage of these tax breaks. Please note that the FEIN needs to be registered to you (establishing a household FEIN is one of the first steps in fulfilling the legal obligations outlined in #1 above).

If you pay a service to help you with household payroll and tax filings, the fees are tax deductible.

More than likely, your employee will see significant benefits from the recently-enacted Making Work Pay initiative. In addition to lower tax rates, the Earned Income Tax Credit has been expanded to provide more tax relief to lower-wage workers, especially those with children. For more info about the EITC, visit www.irs.gov. While there, your employee may want to check out the IRS Free File Program, which provides free tax preparation service to American taxpayers earning less than $56,000 per year.
We hope this information helps make tax time a little easier and a little less expensive. If you have any questions, please don't hesitate to call.