Matters Column

A ‘nanny tax’ horror story from an honest tax expert

November 24, 2012
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The election is over, and the president will soon be naming new cabinet and senior administration appointees. Background checks may reveal various items including tax returns. We have seen in recent history cabinet-level appointees who have not filed correct or complete tax returns and face harsh outcry from members of Congress and the media. This includes the infamous “nanny tax” issue.

The nanny tax issue first came to light in 1993 with one of the Clinton administration appointees. The requirement to withhold and pay payroll-related taxes for household employees still remains today. In some respects, reporting has been simplified since 1993.

Annual reporting for household employee federal taxes has replaced quarterly or more frequent withholding for social security and unemployment taxes (FICA and FUTA, respectively) and withholding taxes. FICA and FUTA taxes are paid with Schedule H with a taxpayer’s annual return. Any household employee with $1,800 or more of payments from their employer must have employment-related taxes paid by the employer on behalf of the employee.

However, the reporting and payment of the taxes doesn’t always go as planned and can make the compliant taxpayer wonder whether it is worth the hassle. In my personal situation, I employed some college-student-aged “nannies” as caregivers for my children over the past nine or 10 years. I have used a payroll processing service to compute and disburse payroll, make certain tax payments and filings, and provide the information needed to prepare and file Schedule H.

The reporting of wage and other information places one into the IRS system of matching and verifying reported amounts. On three occasions, I had situations where the IRS could not match up the data I provided on Schedule H with the Michigan unemployment agency information regarding quarterly unemployment tax payments for purposes of computing any FUTA liability. As a result, a matching notice was generated, and the taxpayer (me) was left trying to prove the IRS matching notice is incorrect. On all three occasions I was able to reconcile any differences and demonstrate the original information that was filed was correct. However, it has taken some considerable effort to resolve these items.

In fact, I have just resolved the 2008 tax year this month. It all started when I received a notice from the IRS in September 2010. It was resolved in my favor some 26 months later. In the meantime, I received notices of intent to assess and had a tax refund reduced in the amount of the incorrectly determined tax.

I first responded to the September 2010 notice in early October 2010 and then received IRS letters for the next six or so months at six or eight week intervals indicating they had received the response, but due to work load at the IRS Service Center, they were unable to review the information. I included a certified copy of the Michigan unemployment tax payments with my first response to assist the IRS in matching up its information with the Michigan unemployment agency information. In May 2011, when the IRS finally responded, the IRS indicated a discrepancy. I reviewed the information and thought I had identified the issue and responded to the IRS to resolve the item. However, in the meantime, the IRS issued an assessment of tax and interest for the liability.

When the assessment notice was issued, I immediately called the IRS Service Center and, after nearly 90 minutes of being on hold and speaking to two different individuals, a hold was placed on the account to allow the IRS additional time to process the letter and other information I had sent a few weeks prior.

When I actually filed my return for 2010 in early October 2011, the IRS reduced my overpayment by the amount of the earlier assessment and not taking into account the information I had provided in May 2011 (so much for the hold on the account).

Once again, I gathered up the documents and sent a package in November 2011 and then resent it again in the summer of 2012. On November 10, 2012, I received a letter indicating that my correspondence had been reviewed and the IRS was adjusting the 2008 tax return to reflect the information I provided earlier. Finally, after 26 months, this is resolved.

But wait — there is more to this story. I also have had some recent issues with Michigan regarding state withholding tax on the nanny wages. Since my children are old enough and do not require the care of a nanny, I no longer have household employees, so, for 2012, I no longer needed to file or pay any state wage withholding tax for Michigan purposes.

Stopping a flow of tax payments must complicate things in Lansing. The Michigan Department of Treasury began to send notices since it was no longer receiving electronic deposits of the state withholding tax; Michigan Treasury then assessed tax and interest for February through May 2012 (each month) for a hypothetical tax since no deposits of any withholding tax were made. I received the February 2012 assessment in late April 2012 after I had notified the state that no electronic deposits were required because of no longer employing any nannies. 

I called Michigan Treasury, which notified me they were behind in processing the information on electronic transfer reporting and I should expect to receive monthly assessments for months to come until they could catch up. They also indicated I needed to respond to any and all notices to avoid having the assessments going into collection mode.

This is some good news to report. After responding to four different monthly assessments and requesting an informal conference, the assessments were cancelled late this summer, approximately four months after the first assessment notices began showing up.

In each of my circumstances, it took significant time and effort for someone who deals with taxes on a daily basis to resolve these items. How does the average citizen trying to comply with the rules deal with the issue? Many taxpayers are confronted with the dilemma of paying a professional more than the actual tax liability and, in the end, surrendering (paying) an inaccurate or incorrect assessment just to end the hassle. In addition, the governmental agencies dealing with these issues may be incurring time and using limited resources to chase law-abiding taxpayers who have actually complied with the law.

Many of you will read this and wonder (as many of my friends have) why risk the hassle and perhaps just not follow the nanny tax rules. My response has consistently been that, as a citizen of this country, I have a responsibility and duty to follow the rules. And if I didn’t, what example would it set for my children? As Benjamin Franklin once said, “Honesty is the best policy”.

Bill Roth is a tax partner with the local office of international accounting firm BDO USA LLP. The views expressed are those of the author and not necessarily of BDO. The comments are general in nature and not to be considered specific tax or accounting advice. Readers are advised to consult their professional advisers before acting on any items discussed.

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