Why that secret cash payment to your nanny could backfire on your taxes

If you're paying your nanny cash under the table, you might catch heat from the IRS.

It's no secret that child-care costs are a massive expense for working parents. Families with infants pay a nanny an average of $580 a week, according to Care.com — or $30,160 annually.

To put things into perspective, average tuition, fees, room and board adds up to $21,370 at a public four-year school and $48,510 at a private four-year school for the 2018-2019 tax year, according to the College Board.

It may be tempting to slip your caregiver some cash off the books, but you're taking a chance with the IRS for failure to pay the appropriate employment taxes.

"It doesn't make sense to risk financial consequences in terms of penalties and tax problems or even getting a felony tax evasion charge," said Tom Breedlove, senior director of Care.com HomePay.

In fact, failing to pay your household workers the right way could hurt you at work, too.

Consider 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.

Most recently, Heather Nauert, a State Department spokeswoman who recently removed herself from consideration to be the next U.S. ambassador to the United Nations, also reportedly had a nanny tax issue.

Here's what you need to know about paying your nanny on the books and what it means for your taxes.

Your tax obligations hinge on a key question: Is your caregiver your household employee?

If you control the work and how it's done, then congratulations: You're an employer, according to the IRS. It doesn't matter if your household employee works part time or full-time, or whether you pay them on an hourly, daily or weekly basis.

This also means that you're on the hook for employment taxes.

If you paid cash wages of $2,100 or more in 2018, then you are obligated to withhold and pay the Social Security and Medicare taxes. This adds up to 15.3 percent of wages, which you'll split with the employee.

If you paid wages of at least $1,000 in any quarter of 2018, you're also on the hook for federal unemployment taxes of 6 percent.

Be aware that your state may also require you to pay state unemployment taxes.

You're also responsible for delivering a Form W-2 to your employee, detailing wages paid and taxes withheld.

Finally, you must also spell out the details on your employment taxes paid when you file your income tax return by April 15. You'll be using Schedule H to do so.

Once you're paying your caregiver on the books, you may be eligible for certain tax breaks.

For instance, if you paid someone to look after your child while you're at work, you might be able to claim the child and dependent care tax credit. This credit maxes out at $1,050 for one qualifying child under age 13 or $2,100.

You'll need your caregiver's taxpayer identification number — generally their Social Security number — in order to claim the credit.

A dependent care flexible spending account can also help you offset some of your child-care expenses.

These accounts, which often are offered as a workplace benefit, allow you to save up to $5,000 a year per household on a pretax basis. Your child must be under the age of 13.

If you want to avoid the headache of paying back taxes, it's best to formalize your relationship with your caregiver. Consider drafting an employment contract so that you can address sick days, vacation time and other details.

"It's always easier to do it right from the get-go," said Breedlove.

Here's the paperwork you'll need for 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.

Consider either working with an accountant or using payroll software — such as NannyPay or HomePay — to stay on top of your tax obligations as an employer.

"If you don't get the right guidance or help at the beginning, you could find it's more expensive than you thought, said Breedlove.

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