There is a common perception that the government does little to enforce household employment tax law – and even when they do, the punishment is nothing more than a slap on the wrist.

The truth is that state unemployment agencies and the IRS have become increasingly aggressive about tax collection – and using severe punishment as a deterrent – because the gap between taxes due and taxes collected (known as “the tax gap”) has become untenable. While financial penalties are still the norm, this case demonstrates that the government is willing to also levy prison sentences in certain circumstances.

The Mistake

The Millers paid their nanny “under the table” from 1994 to 2002. After an audit of their personal income taxes in 2003, the Millers pled guilty to one count each of conspiring to defraud the United States by failing to file household employment tax returns.

The Law

An employer is required by law to pay employment taxes to the state and the IRS, in addition to withholding taxes from their employee’s pay. Failure to do so is considered felony tax evasion.

The Mess

  • Once convicted, the Millers were required to make financial restitution (back taxes plus penalties and interest for each of the years PLUS the employee’s portion of social security and medicare taxes that should have been withheld). They were given five years of probation, conditioned upon meeting the restitution agreement and future tax obligations.
  • In December 2006, the probation officer filed a petition to revoke the Millers supervised release because they had failed to make payments against their restitution agreement and also failed to file their personal tax return for 2005. This revocation meant the Millers would go to prison.
  • Wanting to avoid prison, the Millers filed an appeal with the Eighth Circuit Court of Appeals. The appellate court upheld the original ruling so the Millers are now serving prison sentences of 14 months and 13 months, respectively.

The Outcome

After years of stressful and time-consuming audits, depositions and court proceedings, the Millers have begun serving their sentences. When they are released from prison in mid-2010, they’ll be jobless, heavily-indebted felons. Worse, since they each held a professional license which is revoked upon felony conviction, both will have far less earning potential when they re-enter the workforce. For their children’s sake, let’s hope they’re ultimately able to work themselves out of this financial hole.

How the Whole Thing Could Have Been Avoided

The Millers are similar to many other professional families who employ nannies. Hearing that many people pay their nanny “under the table,” they rationalized their non-compliance as a victimless crime – and a necessary evil in order to provide quality care for their children. What makes their situation unique is simply that the amount of tax debt grew to a point where it overwhelmed their ability to pay. The accumulation of nine years of employer tax debt – along with the ensuing legal fees, penalties and interest – literally broke the bank.

Had they paid legally from the beginning of the relationship, the tax costs would have been infinitely more manageable – especially when you factor in the ability to take advantage of tax breaks for childcare expenses. As the Millers have learned (unfortunately, the hard way), paying a nanny illegally is a highly risky decision with potentially devastating consequences.