[Editor’s note: Welcome to the Underground Economy series, which delves into the business of illicit, under-the-table, or otherwise accepted-but-not-quite industries. The previous installment explored the world of street vendors in the U.S.–check it out here. Today’s installment deals with nannies and babysitters!]
In the U.S., nanny-based childcare services are on the rise. As prices for daycare centers increased, many families are deciding that in-home child services are better. In recent years, daycare centers went from an average of $1,200 per month to $2,000. Notably, pandemic factors contributed to these increases, but they were not the only ones. Parents responded by exploring other options including hiring nannies in their home. By paying nannies under the table, many saw a way to come out ahead. But avoiding the “nanny tax” and failing to claim in-home childcare has its risks. And these risks aren’t only for the family but for nannies as well.
For the vast majority of families employing a nanny, the IRS requires payments to be reported and taxes paid. By rough estimates, it would seem about 85% of families with nannies fall into this category. Paying these taxes are a bit challenging because of the various forms that must be filed. Likewise, it requires keeping track of payments and reduces the take-home pay nannies receive. Because of this, avoiding the nanny tax and paying nannies under the table has become more of a norm than most appreciate. However, the detrimental effects and risks these practices have on the nanny, the family and society are substantial. This is why strategies to better address this aspect of the underground economy is essential.
The Pervasive Nanny Tax Issue
There is a sizable number of households in the U.S. today that employ nannies and babysitters. According to recent IRS statistics, roughly 550,000 nannies exist today in the country, each having 1.5 different employers. That means there are around 825,000 families that have nannies providing childcare services. But despite these figures, the same estimates suggest less than 6% file the appropriate IRS forms as nanny employers. Thus, the overwhelming majority avoid paying the nanny tax and instead are paying nannies under the table. Based on these figures, lost tax revenues from these payments range somewhere between $1-2 billion annually. These are staggering numbers that deserve attention.
In order to appreciate the impact of not paying the nanny tax, it’s important to understand what it entails. Currently, any family that pays an individual more than $2,400 annually for childcare services must file. By claiming these payments, families are then obligated to pay various employer taxes. This includes those related to Social Security and Medicare, which employers must pay under FICA. Likewise, it includes additional employer taxes under FUTA that covers things like Worker’s Compensation and Unemployment Benefits. Together, these deduct around 16% of wages from the nanny’s earnings, which reduces take-home pay. And given the choice, many workers will choose families paying nannies under the table over those that don’t.
Motivations for Paying Nannies Under the Table
Understanding how few families pay the nanny tax who should be, there must be clear incentives present. The most notable one relates to the challenges finding a well-qualified nanny or babysitter. In the last few years, wages have increased substantially for all childcare services. Dual income households demand such services, yet supply has failed to keep pace with these increases. Closures and restrictions at daycare centers during the pandemic did not help as many childcare professionals changed careers. By not paying the nanny tax, families have a chance to offer nannies or babysitters a higher take-home wage. This might mean the difference between securing childcare or losing a potential hire to another family. And for some families, this could affect whether a parent is able to leave home to work.
The other factor motivating families to avoid the nanny tax relates to the complexities of filing in the first place. While plenty of assistance is available for filing nanny tax documents, including e-solutions, the additional burdens persuade families otherwise. Payment records must be kept, taxes calculated and paid, and forms filled out and filed. Given the other responsibilities families have, it can be hard to get excited about these additional tasks. These can naturally be avoided by paying nannies under the table, which is much more straightforward. As long as everyone is on the same page, this seems like the path of least resistance. But it’s also one that has notable risks and detriments for all involved.
The Downsides of Avoiding the Nanny Tax
When it comes to the risks involved of paying nannies under the table, all stakeholders have risks. For families, the biggest risk is getting caught by the IRS for avoiding the nanny tax. If caught, back taxes will need to be paid along with fines and penalties. And in some instances, tax evasion criminal charges may be filed, which is a felony. While this may seem unlikely, families have been exposed by prior nannies resulting in IRS investigations. In some instances, a disgruntled nanny may directly contact authorities. In other instances, nannies filing for unemployment can alert officials of the illegal payment practices. Regardless how it occurs, families place themselves at risk when paying nannies under the table.
Nannies and babysitters also face some unfortunate effects when the nanny tax is avoided. When FICA and FUTA taxes are paid by employers, employees are unable to accumulate Social Security credits. They also lack access to Worker Compensation protections and Unemployment Insurance protections. Plus, without verifiable income, they struggle with loan approvals, mortgages, and even housing access. Landlords are reluctant to rent to anyone who cannot provide a verifiable employment history. Given that most nannies are women, minorities and lower education, these impacts are felt by society’s most vulnerable. Over the long-term, these downsides are much more significant than the short-term gains.
A Three-Pronged Approach Is Needed
Understanding the issues and negative effects involved, several different solutions are needed to improve nanny tax compliance. First, nannies and families both need innovative ways to educate them about the risks and downsides of the situation. This is a priority to persuade stakeholders that paying nannies under the table is a bad idea. Secondly, greater enforcement efforts are needed to ensure compliance. It is well-noted that the IRS has limited resources, but better oversight is still needed to improve the situation. Finally, paying the nanny tax and complying with federal and state requirements needs to be streamlined. Reducing complexities and barriers will persuade many families to comply. While these efforts won’t solve everything overnight, they will lead to notable improvements. And the tax revenues earned from these efforts can be leveraged to support their existence.