NEW YORK (CNN/Money) - Bernard Kerik, the would-be Homeland Security chief, is only the most recent in a long line of candidates for high office to be doomed by the so-called nanny tax.
Though Kerik's disclosure was embarrassingly public, it turns out that off-the-books household employment is widespread. An estimated 2 million people work as nannies, maids, and at other in-home jobs in the United States.
The Federal Government requires employers to file tax returns for anyone earning more than $1,400 (the 2005 threshold) annually. Yet in 2001, the IRS collected only about 250,000 of the required Schedule H's, a compliance rate of less than 13 percent.
So what about the other 87 percent? Are they fine as long as they're not hoping for a stint as a federal judge? Are they even saving that much money flouting the tax laws?
It pays to play it straight
If the IRS catches you cheating, it can collect not only the back taxes, but penalties and interest too. Then there's the time and possible legal costs involved in fighting the charges.
According to Jo Ann Pinto, professor of accounting at Montclair State University and co-author of a paper for The CPA Journal entitled "Hidden Benefits of the Nanny Tax," there can be professional sanctions for attorneys, accountants, and others who violate ethical standards.
Compliance does not cost that much, according to Pinto, averaging about 12 percent in extra payroll costs.
"A lot of that cost of compliance can be underwritten by the government," said Pinto. Many people with nannies are in the top tax bracket. Government tax credits for childcare can reduce the taxes they pay.
Say you pay a nanny $30,000 a year, on the books. If your company has a childcare FLEX account plan, it allows you to shelter as much as $5,000 in pre-tax income. That could shave $2,000 or more from your tax bill, enough to offset more than half the extra costs of complying with reporting laws.
If your company doesn't offer FLEX accounts, you can still take a childcare credit by filling out Form 2441. The benefit depends on income, but it can save as much as $1,500 a year in taxes.
Making it easier
Were it easier to do, some people might comply with IRS rules more happily.
Guy Maddalone, CEO of GTM Household Employment Services and author of the book "How to Hire & Retain Your Household Help," estimates it would take 60 hours a year to do the books required for employing household help legally. Many would rather hand out cash once a week.
GTM -- and many other human resource service companies -- can take over the paperwork problem. "We set people up as legitimate employers," Maddalone said. The firm determines if workers are eligible to work in the United States, then handles all their forms and procedures, including sending withholding and payroll taxes to the government, issuing employees' checks or making direct deposits, and sending out schedule Hs and W-2s.
The service costs $75 to get started and $48 a month afterwards.
A slightly more expensive alternative is to have the accountant who does your annual taxes handle your employer paperwork as well.
Better for everyone
Of course many domestic employees encourage their clients to pay them off the books, if only to pump up their net. That can be pound-foolish for both parties, according to Pinto.
"Employees are so much better on the books," said Pinto. She points out that low-paid workers may qualify for earned income credits of as much as $4,000, but only if they file tax returns. In addition, they'll receive Social Security benefits and Medicare when they retire and disability insurance and workmen's comp coverage while they're working.
They'll also have unemployment insurance. When Pinto's grandmother, who employed an elder care worker, went into the hospital for a few weeks, the worker was able to collect unemployment payments. The worker didn't need to find a new job during those weeks and the employer didn't need to hire a new worker.
So before you decide to do an end run around the regulations, crunch some numbers. You may find that it won't cost too much more and will contribute to your peace of mind.