Recent study shows an alarming increast in the number of parents who stopped paying the nanny tax.  Household-employment tax filings for nannies and other domestic workers fell 10% in the five years ended in 2006, based on the latest Internal Revenue Service data — a period when the number of domestic employees actually rose, according to Labor Department data.

As a rule of thumb, it’s never wise to evade taxes, but the trend poses particular risks now. The down economy means more nannies are likely to be laid off and then file for unemployment benefits, drawing the scrutiny of tax regulators, attorneys say. Also, avoiding the taxes leaves nannies devoid of a safety net, including Medicare and Social Security benefits, in an era when they may need it more than ever.

Since 1996, tax filings are down 26%, to 225,441. Growth in online hiring, and the casual, cost-averse attitudes of parents who find their nannies on the Web, are among the causes, parents and industry sources say.

The law says that people who pay household workers more than $1,600 a year, are required to file onerous paperwork to cover Social Security and Medicare taxes of 7.65% of gross pay; federal unemployment insurance of 0.8%; state unemployment insurance, usually of 2% to 4%, and other state and local taxes. The employee’s share is another 7.65% for Social Security and Medicare, plus any state and local taxes. Many parents spend $30 to $70 a month to have a payroll service handle all the red tape.

In the past, parents more often hired full-time nannies through traditional nanny agencies, which often persuaded both parents and nannies to pay taxes. Also, periodic derailings of presidential cabinet appointees over nanny-tax violations, highlighted the hazards for scofflaws.

Online nanny hiring and a related trend toward more fluid, short-term and part-time nanny employment have damaged compliance, according to major nanny agency website, payroll managers, attorneys and nanny-agency owners. An estimated 30% to 50% of nanny hires are now done online, up from about 10% five years ago.

Many nannies hired online assume they’ll be paid cash. To avoid this, Marijo Montgomery, a Mullica Hill, N.J., parent, has begun specifying “no pay under the table” in nanny ads she posts online, she says.  In other cases, scofflaws employ undocumented immigrants. Still others simply don’t see a payoff in filing taxes. After talking to a friend who does so, says a San Diego mother of two boys, “it sounded like a lot of work, and neither party wins — we pay more and the nanny gets less.”

In truth, both parties stand to lose from evading taxes. One parent who paid his nanny cash fired her last month, only to be found out by state officials after she filed for unemployment benefits, says Bob King, an attorney and founder of Legally Nanny, an Irvine, Calif., employment-services firm. While nannies in these cases may find themselves on the hook for some back taxes, parents face a much larger hit, including both the nanny’s and the employer’s share of payroll taxes, plus interest and penalties.
   Complying with tax laws, on the other hand, enables parents to set aside up to $5,000 in pre-tax income for child-care expenses. It also extends to the nanny Social Security and Medicare benefits. “If parents really care about their nanny and love her, as so many families do,” says Steve Lampert of eNannySource.com, an online search service, “then it’s the right thing to do for her.”
For other parents, it’s even simpler. Although Dina Appleby, Kennett Square, Pa., and her husband don’t enjoy paying nanny taxes, “we’re both strong believers,” she says, “in following the law.”

Tackling Taxes
Resources for those who employ a nanny:

• ‘How to Hire a Nanny,’ by Guy Maddalone Guidebook covers tax issues
• irs.gov Search for Publication 926, Household Employer’s Tax Guide
• Breedlove-online.com/faqs Q&A on tax issues