Indiana Law Review


Protecting the Hand that Rocks the Cradle:
Ensuring the Delivery of Work Related

Benefits to Child Care Workers

Debra Cohen-Whelan*

Introduction

Illegal child care has taken a center stage as the nanny tax trap has snared

politicians/ political appointees,^ and candidates for political office.^ Media
attention given to the nanny tax scandals raised public awareness and stimulated

debate on issues ranging from finding qualified in-home child care providers and

* Associate Professor of Law, Whittier Law School. B.A., 1987, Howard University;
J.D., 1990, University of Virginia School of Law.

1

.

White House lawyer William Kennedy was stripped of his duties overseeing background

checks of administrative employees after it was discovered that he attempted to conceal the fact that

he had not paid taxes for a nanny employed by his family. See Douglas Jehl, White House Aid Who

Failed to Pay a Tax Is Punished, N.Y. TIMES, Mar. 21,1 998, at 1

.

2. Zoe Baird and Kimba Woods both withdrew their nominations for attorney general after

allegations surfaced that they had hired illegal domestic workers. The focus on non-critical issues

such as Nannygate has disqualified excellent candidates such as Baird and Woods, depriving the

nation of their service. See Stephen Carter, The Confirmation Mess: Cleaning Up the

Federal Appointments Process (1994). Janet Reno, a single woman with no children, was later

confirmed as the nation's first woman attorney general.

3. In California, the 1994 Michael Huffington-Diane Feinstein senatorial race was plagued

with nanny tax allegations. First, it was discovered that Huffmgton had employed an illegal

inmiigrant to work in his home as a housekeeper/nanny for more than four years. In an advertising

campaign, Huffmgton accused Feinstein of also employing an illegal housekeeper. Feinstein

countered that she had hired the woman long before enactment of the 1986 federal law that made

it a crime to hire illegal workers, had checked the women's visa to verify her employment status,

and had paid all ofthe required employment taxes. Feinstein claimed that she was unaware that the

woman's visa was valid for only one year and was conditional on her employment at the

Guatemalan Consulate in San Francisco. The INS later verified Feinstein 's story, stating that the

employee did have a valid visa and that only an expert would be able to detect the employment

limitations. While Feinstein's defense upheld public scrutiny Huffmgton did not fare as well. Days

after a local television station poll showed Huffmgton with a two-point lead, another station

released a poll showing Feinstein with a 16-point lead over Huffmgton, up 10 points from a poll

taken two weeks earlier. The station attributed Huffington's drop in the polls to his disclosure

about employing the illegal worker. See Patrick J. McDonnell et al., Feinstein Worker Entered U.S.

Legally, hut Visa Lapsed Politics: INS Records Indicate No Violation ofFederal Law, L.A. TIMES,

Nov. 5, 1994, at Al.

During the 1998 California gubernatorial primary race, allegations resurfaced that

Representative Jane Harman broke the law by hiring an illegal nanny. The allegations first became

public when Harman voluntarily disclosed the information in defense of Zoe Baird and Kimba

Woods. Harman lost the primary to challenger Grey Davis, who was later elected Governor of

California. Nanny Allegations Resurface, CONGRESS DAILY, Apr. 27, 1998.



1 1 88 INDIANA LAW REVIEW [Vol. 32: 1 1 87

the child care demands ofwomen in the work force, to the archaic and confusing
legal requirements associated with the payment of employment taxes for
household employees.'* Child care issues also received unprecedented attention

in the political dialogue.^ Congressional consideration of the nanny tax
compliance problem prompted legislative simplification of the employment tax
reporting requirements for household employees.^

The payment of employment taxes by household employers is only half of
the issue. The political rhetoric has ignored the effects of noncompliance on
household employees. Some laborers have jobs paying less than the minimum
wage, and they receive no overtime or health care benefits. These workers, who
are predominantly women, will be unable to receive social security benefits upon
retirement, unemployment benefits if they are suddenly discharged, or disability
benefits in case of illness or accident.

Many in-home child care providers endure third-world working conditions.
The images of illegal immigrant workers, who toil in the soil, digging and
picking the fruits of our agricultural labor, or work fourteen-hour days in
sweatshops^ for little money and no benefits, spawn protests and boycotts.*
However, little consideration is given to the plight of workers, both legal and
illegal, who iron clothes, scrub floors, and change diapers every day in numerous
American homes. These workers provide services subordinate to other wage
laborers with respect to status, salary, and opportunities for advancement. Their

average yearly income barely exceeds the poverty line. And they are virtually all
women.

In our own employment relationships we may be in a position to bargain for
decent wages, medical benefits, educational assistance,^ and other accouterments

4. See Rochelle L. Stanfield, Child Care Quagmire, Nat'l L.J., Feb. 27, 1993, at 512

(quoting Mary Whitebrook, Director of the Oakland-based Child Care Development Project, who

commented that the scandal is helping to break the silence about the child care problem and raise

the awareness of the public, policy-makers, and the media).

5. Senator Daniel Patrick Moyihan (D-NY) introduced a bill to reform the employment tax

requirements. A similar bill was introduced in the House of Representatives by Andrew Jacobs,
Jr. (D-IN).

6. Social Security Domestic Employment Reform Act of 1994, P.L. 103-387, 108 Stat.

4071 (1994). See infra notes 26-41 and accompanying text for a discussion of this act.

7. See Lora Jo Foo, The Vulnerable and Exploitable Immigrant Worlrforce and the Need

for Strengthening Worker Protective Legislation, 103 YALE L.J. 2179, 2181 (1994) (citing U.S.

Gen. Accounting Office, Pub. No. GAO/HRD-88-130BR, "Sweatshops" in the U.S.: Opinions

ON Their Extent and Possible Enforcement Options 16(1 988). A sweatshop is defined as "a
business that regularly violates both wage or child labor laws and safety or health regulations.").

8. Activists targeted Nike and Disney with protests and boycotts following reports from

the National Labor Committee that workers producing Nike shoes in Indonesia earn as little as two

dollars per day and make as many as 100 shoes a day. Many of the workers are children, some as

young as ten years old, and work up to 18 hours a day. See Diana Griego Erwin, Children 's Labor

Cheapens Our Gifts, SACRAMENTO BEE, Nov. 26, 1996, at 31.

9. IRC § 129 authorizes the establishment of employer educational assistance programs.



1 999] PROTECTING CHILD CARE WORKERS 1 1 89

that middle class workers expect to receive in exchange for their labor. For a

fortunate few, child care is part of the compensation package.'^ When both
parents work outside of the home, employer-provided child care is the ultimate
perquisite.'^ Other hard working American families are faced with a dilemma:

Who will mind the kids? Immediate and extended family members may not be
available or reliable.'^ As the average work day increases, the eleven-hour daily
schedule of most day care facilities may not provide adequate child care
coverage. Reliable in-home child care is the only alternative for some working
families.

As the cost of in-home child care increases, even families that can "afford"
in-home child care struggle to pay the exorbitant salaries demanded by
experienced nannies.'^ Many nannies, however, will accept a lower fee on the
condition that they are paid under the table to increase the amount of money they
actually take home. Hiring an illegal immigrant child care provider presents

another more affordable in-home child care option.*"^ Illegal immigrant child care
providers are paid lower wages and will often work longer hours than their legal
counterparts.'^ In either case there is a great incentive to avoid federal laws that

Employees participating in an employer educational program may receive tax-free payments of

tuition, books, and supplies worth up to $5250. I.R.C. § 129 (West Supp. 1998). For further

discussion of this section, see infra notes 130-35 and accompanying text.

10. See generally Christine A. Clark, Review ofFlorida Legislation; Comment: Corporate

Employee Child Care: Encouraging Business to Respond to a Crisis, 15 FLA. ST. U. L. REV. 839

(1987). Professor Clark notes that employers have been slow in responding to the changing

demographics of the work force and have failed to provide most working families with child care

options. Id.

1 1

.

Day care has become a major workplace issue for working mothers. Only two percent

of American employers provide their workers with day care. Employers providing day care tend

to be large companies such as Motorola and Eli Lilly. See Kim Phillips, The Parent Trap in These

Times, iNST. FORPub. Aff., Feb. 1997.

12. See id. Many women are forced to rely on relatives for day care when no other options

are affordable or available. However, friends and family members are notoriously unreliable. Even

if keeping child care in the family provides the best environment for the child, many adult family

members are working as well.

13. See infra notes 90-91 and accompanying text for a discussion of wages paid to

experienced, educated nannies.

14. Throughout this Article, use of the term "illegal immigrant child care worker" is

distinguished from "illegal child care worker." The author intends illegal immigrant child care

worker to mean someone who is ineligible to work in the United States. Based on this definition,

legal workers include workers with documentation of United States citizenship, lawful residence,

or INS work authorization. When referring to an illegal child care worker, the author intends to

include any worker who is a citizen, resident, or other individual who is authorized to work in the

United States, but who fails to comply with federal and state employment tax laws or to report

earned income.

15. See Kathleen A. Delaney, Note, A Response to "Nannygate:" Untangling U.S.

Immigration Law to Enable American Parents to Hire Foreign Child Care Providers, 70 IND. L.J.



1 1 90 INDIANA LAW REVIEW [Vol. 32: 1 1 87

require household employers to hire legal household workers and pay
employment taxes.

The delivery ofchild care services results from the formation ofa partnership
between parents, private child care providers, and the public. ^^ The federal tax
laws reign as the key element of the public paradigm.*^ The provisions that
command the payment of employment taxes are found in the Internal Revenue
Code (the "IRC"),'^ as is the child care tax credit,'^ which provides a federal tax
rebate for child care expenses. The child care credit is in fact the largest federal
child care subsidy available to taxpayers with dependent children.^^

Reliance on limited tax credits to subsidize the cost of child care is
symptomatic of a federal tax policy that provides rebates to taxpaying families
but fails to consider the interests of child care providers. Federal child care tax

expenditures, such as the child care credit, can be utilized to elevate the status of

domestic work, allowing child care providers to achieve economic parity with
other laborers. Advancements in the working conditions associated with in-home
child care work will make domestic employment a more attractive employment
option for women, particularly women who are re-entering the workforce after
raising children of their own.

The failure to require household employers to establish legal employment
relationships with child care providers devalues domestic work and produces
adverse economic consequences that extend beyond the exploitation of any
individual worker. Child care workers who do not receive wages and benefits
necessary for their basic subsistence must rely on other sources of financial

assistance. Ultimately the cost of supporting domestic workers and their families

shifts to the public through government programs such as Medicaid, Aid to
Families with Dependent Children ("AFDC"), and food stamps. The importance
ofthese issues justifies the establishment of a federal tax policy that protects the

interests of household employees and their families by shifting the economic

burden of providing for these workers to the employers for whom they work.
However, the tax code and its enforcers have done little to encourage household

employers to pay employment taxes for their household employees.
The purpose of this Article is to explore why compliance with the federal

domestic employment tax laws has decreased despite simplification of the

305, 314 (1994) (quoting Ellen Sehgal & Joyce Vialet, Documenting the Undocumented: Data,
Like Aliens, are Elusive, MONTHLY LAB. REV., Oct. 1990 at 18, 20).

16. See Sharon C. Nantell, The Tax Paradigm ofChild Care: Shifting Attitudes Toward a

Private\Public\Parental Alliance, 80 Marq. L. Rev. 883 (1997). The author refers to the delivery

of child care services to parents through private child care providers with federal subsidies. Id. at

907-09.

17. See id at 909.

18. I.R.C. §§ 3101 (1994), 3102 (West Supp. 1998).

19. I.R.C. § 21 (West Supp. 1998). See infra notes 149-55 and accompanying text for a

discussion of the child care credit requirements.

20. See Stanfield, supra note 4, at 5 12. It is estimated that 60% of the $7 billion in federal

child care subsidies paid in 1991 were paid through the child and dependent tax credit.



1 999] PROTECTING CHILD CARE WORKERS 1191

requirements for paying the tax.^^ This Article examines noncompliance with the

nanny tax by household employers and suggest proposals for change. The issues

raised in this Article apply with equal force to all domestic employees who are
denied the benefits afforded other paid laborers, not just nannies. However,

establishing a policy to protect the rights of in-home child care providers is the

specific focus of this Article because there are current tax provisions that grant

tax incentives for child care expenditures.

The Article begins by providing background information on the nanny tax
and its payment. In Part III, the Article considers non-compliance by household

employers. This section suggests several reasons for tax avoidance by domestic

employers, including: the expense and administrative burdens associated with

paying employment taxes; the proliferation of illegal child care providers and

their effect on compliance with employment tax provisions; the tendency to
dissociate domestic work from other professions where labor is performed
outside of private homes; and the under-enforcement ofthe nanny tax provisions.

Part IV ofthe Article addresses the long-term costs to both the employers and
employees who fail to follow the law. Part V considers the role ofthe child care
credit and the disallowance ofa deduction for in-home child care in discouraging

employers to pay employment taxes for their household workers. This Article
suggests that household employer compliance will increase if household

employers and their employees are informed ofthe benefits associated with legal

employment, threatened with sufficient punitive measures to deter under

reporting, and given tax incentives that mitigate the expense of paying the nanny

taxes.

I. Payment OF THE Nanny Tax

There are federal and state tax implications associated with hiring a

household employee. Domestic employers are required to pay social security and

Medicare ("PICA") taxes and federal unemployment ("FUTA") tax.^^
Collectively these federal taxes have been referred to by the media as "Nanny
Taxes." The nanny tax burden is divided equally between the household
employer and employee.^^ In addition to the required employment taxes (PICA

2 1

.

See infra notes 31-37 and accompanying text for a discussion of the simplification of

the employment tax payment procedures.

22. The employer and employee must each pay FICA and FUTA taxes. The social security
tax is 6.2% up to a wage ceiling that is adjusted annually for inflation ($61,200 for 1995 and

$62,700 for 1996, 1997, and 1998). The Medicare tax is 1.45% and has no wage ceiling. The total

nanny tax is 15.3% of the employee's cash wages. See I.R.C. §§ 3101(a) «& (b), 311 1(a) & (b)
(1994).

23

.

See Efrem Z. Fisher, Child Care: The Forgotten Tax Deduction, 3 Cardozo Women's

L.J. 113, 117 (1996). The employer may choose to pay the employee's portion of the social

security and Medicare taxes instead of withholding the taxes from the employee's cash

compensation. When the employment taxes are paid by the employer, the taxes are not included

as wages subject to further employment tax. However, payment ofthe employee's employment tax



1 192 INDIANA LAW REVIEW [Vol. 32: 1 1 87

and FUTA), the employer may agree to voluntary federal income tax
withholding.^"^ Domestic employers may also make advanced earned income
payments to qualifying employees.^^

Four years ago Congress simplified the procedure for reporting wages paid
to domestic employees, including nannies, by enacting the Social Security
Domestic Employment Reform Act (the "Reform Act") of 1994.^^ The Reform
Act permits domestic employers to annually pay and report employment taxes on
their own Form 1040, Schedule H.^^ The Reform Act provides that employment
taxes (FICA and FUTA) must be paid by individuals who employ domestic
workers, such as nannies, whom they pay $1000 or more in any taxable year.^^
Domestic service provided by certain family members and any individual under
the age of eighteen whose principal occupation is not domestic service are
exempt from the nanny tax requirements.^^

Under prior law, household employers were required to file quarterly
statements, end-of-the-year wage and tax statements, and end-of-the-year
transmittal of income and tax statements.^^ The Reform Act made three

liabilities requires inclusion of the amount in the employee's gross income. The employee may

ultimately bear the burden of the entire tax if the employers contribution is taken out in the form

of lower salary. See id.

24. The IRC exempts household employers from the withholding requirements.

Remuneration paid for household services performed by an employee in the home of the employer

is not subject to withholding. I.R.C. § 3401. Income tax withholding is not required from wages

paid for domestic services performed in private homes and clubs provided it is not used primarily

to supply board or lodging as a residence. See A Guide to the Nanny Tax, Fed. Tax Coordinator

(RIA), HH 109, 111. Household services include services performed by cooks, maids, governesses,

and babysitters. See Treas. Reg. § 3 1.340 1(a)(3)- 1(a)(1) (1998). An employer, however, may

voluntarily agree to withhold federal income taxes for the nanny's wages. See id.

25. See I.R.S. Notice 89-95, 1989-2 C.B. 417. If the employer withholds income tax, the

employer must give the employee notice as to the earned income credit. If the employee provides

the employer with an Earned Income Credit Advances Payment Certificate, then the employer must

make the advanced earned income credit payment to the employee as requested. The payments are

made out of the employment taxes paid by the employer. See id.

26. P.L. 103-387, 108 Stat. 4071 (1994).

27. I.R.C.§ 3510(a) (1994).

28. The threshold amount was $1 100 in 1998. See I.R.C. § 3 121(x) (West Supp. 1998).

29. See I.R.C. § 3121(b)(21) (1994).

30. IRC § 35 10 provided that returns with respect to domestic service be filed on or before

the 15th day of the fourth month. I.R.C. § 3510. Thus, employment taxes, social security taxes,

and Medicare taxes were paid every quarter. Federal unemployment taxes were paid annually, but

individual states may require more frequent payments. A Form W-2 must be given to the employee
reporting wages paid during the last year. A copy is then sent to the Social Security Administration.
An Employer's Quarterly Tax Return for Household Employees (IRS Form 942) must also be filed

every quarter. See Dan Moreau, Got Household Help? Get This Right: IfYou Payfor Child Care

or Housework, Chances are Good You Owe the IRS a Form 942, KiPLINGER'S Pers. Fin. Mag., Jan.

1994.



1 999] PROTECTING CHILD CARE WORKERS 1 1 93

fundamental changes to simplify the payment of employment taxes and
significantly reduce the administrative requirements associated with the payment

ofthe tax.^* First, it eliminated the quarterly reporting requirements?^ Second,

it increased the threshold amount from $50 to $1000.^^ Third, it exempted wages

paid to certain family members and weekend baby sitters.^"*
The purpose of the law was to establish new enforcement mechanisms and

to improve employer compliance to ensure that domestic workers receive the

social security and unemployment coverage to which they are entitled.
^^

Congress was hopefiil that the new law would increase the number of employers
paying the tax by providing a simplified payment procedure and having taxpayers

sign under penalty of perjury that the household employer owed no taxes for the
year.^^ While taxpayer response to the new rules was immediate, it was not what
Congress had anticipated. The simplification of the nanny tax reporting
requirements has had an adverse effect on nanny tax compliance.^^

The numbers are alarming. In 1994, the number of household employers
filing employment tax returns was 500,000.^^ In 1995, the first year the new law
was in effect the number fell to 300,000.^^ In 1996, the numbers remained
approximately the same and were not expected to increase in 1997."*^ In the end,

the legislative effort to protect the interests ofdomestic employees resulted in the

number of domestic employers paying the nanny tax plummeting by almost forty
percent."^^

II. Reasons FOR Noncompliance

Household employers evade the payment of employment taxes for a variety
of reasons. The ease with which household employers break the law by not
paying employment taxes may not reflect complete disdain for the tax itself, but
may be an indictment on the system that commands its payment.

31. See H.R. REP. No. 103-491, at 3266 (1994).

32. This change was implemented with the addition of Line 52 to the individual income tax

return asking for the amount of Social Security and Medicare taxes owed for household workers.

33. P.L. 103-387, § 2, 108 Stat. 4071 (1994).

34. Id.

35. See H.R. REP. No. 103-491, at 3266.

36. Under the new law, nanny taxes are reported on Line 52 of Income Tax Form 1040.

This form is signed under penalty of perjury. Taxpayers who fail to pay nanny taxes are lying to

the government.

37. See IRS Finds More People Are Skipping Nanny Tax Simplified Rules Bring Increase

in Cheating, Cm. Trib., Apr. 5, 1998, at 15. The Chicago Tribune reports that based On estimates

as many as four million people owe nanny taxes, but fewer than one in 13 are complying with the

law. Id.

38. See id

39. See id.

40. See id.

41. See id



1 1 94 INDIANA LAW REVIEW [Vol. 32: 1 1 87

Succumbing to the temptation to cheat on your taxes is almost inevitable
when no one else is paying the tax. Extreme noncompliance trivializes the law
to the point that breaking it seems prudent rather than immoral. The
politicization of the nanny tax issue has not helped, as taxpayers perceive the
media debate over the payment of nanny taxes to mean that only those with
political aspirations need obey the law."^^ In fact, many household employers may
not recognize the establishment of an employee/employer relationship with their

household worker."*^ For most of us, the term "nanny tax" is associated with
women like Mary Poppins or Alice on the Brady Bunch, instead of Jane
Neighbor from the apartment next door who comes over every afternoon to watch
the kids.

Many taxpayers view the Internal Revenue Service ("IRS") as the enemy,
and are distrustfiil ofany attempt to collect taxes owed, even if properly assessed,

making even otherwise honest people more comfortable with evading taxes
owed."*"* Part of the problem is that as with other taxes, the economic burdens
associated with paying the nanny tax are relatively large in relationship to the
perceived benefits."*^ It is the child care provider who is the direct recipient ofthe
benefits associated with the payment ofthe nanny tax."*^ However, the child care

provider is a potential taxpayer, also motivated by tax avoidance. Therefore,

many child care providers may be willing to forgo the long-term benefits of
reporting their income in order to satisfy short-term financial needs. Because the

42. See id. As one working mother puts it, "My accountant told me I have to stop this and

issue paycheck stubs and report what I pay to the IRS .... But since no president is ever going to

nominate me for the Cabinet, what do I care about paying this stupid nanny tax? And if I get

caught, I'll just pay the fine and go on doing what I am doing." Id. This mother's extreme focus

on her own self interest and complete disregard for the long-term economic security of her nanny

typifies the plantation mentality that pervades domestic employment.

43. The nanny tax is triggered in any year in which the household worker is paid in excess

of $1000. See I.R.C. § 3121(a)(7) (West Supp. 1998).

44. See Joshua D. Rosenberg, The Psychology of Taxes: Why They Drive Us Crazy and

How We Can Make Them Sane, 16 Va. Tax. Rev. 155, 157 n.2 (1997); see also id. at 174 n.45.
In support of this position. Professor Rosenberg gives the following example;

When law school tax classes discuss the fact that a taxpayer who finds $100 is subject

to tax on that treasure trove, students ... ask "why would anyone report it anyway?"

If a student replies "it's the law," her answer is more often than not met with derisive

laughter; yet those same students who laugh at the idea of paying $31 in tax (assuming

a 31% marginal tax rate) . . . would not steal $31 from a classmate even if they were

assured they would not be caught ....

Id

45. See id. at 171-72. The problem with taxes is the association between the payment of

taxes and frustration and sacrifice. The separation of tax benefits and government services from

burdens create the impression that the taxes are punishments. See id.

46. See id. at 179. Professor Rosenberg suggests that the reason taxpayers do not realize

what they are paying for with their tax dollars is that the person who actually pays the tax enjoys

no more benefits than the person with equal assets who evades the tax. Id.

1



1 999] PROTECTING CHILD CARE WORKERS 1 1 95

employer and the employee both perceive the benefits of establishing a legal

employment relationship as minimal in comparison to the immediate economic
burdens, incentives must be provided to encourage compliance.

A. Paying the Price

Many household employers fail to pay their nanny taxes because it is too
expensive. The cost of employing an in-home child care provider exceeds the
cost of other types of child care, such as day care facilities, or group care in

private homes.'*^ Most families find that paying the child care is a financial
strain. After mortgage and rental expenses, child care represents the largest item

on many family's budget."*^
Paying employment taxes increases the cost of child care substantially.

Based on one estimate the average salary of a fiill time nanny is approximately

$280 per week, or $14,500 for the year."*^ Social security and PICA on this
amount are $2218 per year.^° Because of the prevalence of illegal employment,

many nannies may be unv^illing or unable to pay their share of the employment
taxes leaving the employer paying the entire amount. In addition the employer

must pay FUTA and state taxes for disability and unemployment insurance. In
the end, compliance with the employment tax laws amounts to approximately
$2500.'^

B. Red Tape

The complications associated with paying household employment taxes
provides an additional reason for noncompliance by household employers.

Under current law, federal employment taxes are reported, and paid, annually on
the employer's Form 1040.^^ However, payment ofemployment taxes at the end
ofthe year requires detailed record keeping throughout the year. The employee
must be given a Form W-2 for income tax purposes, a copy ofwhich must be sent
to the Social Security Administration. To accurately report income on Form W-
2, the household employer must account for all cash wages paid to the employee

for the year. To complete Form W-2, the employer is required to follow complex
instructions and perform mathematical calculations that many taxpayers find
intimidating.

In addition to the federal income tax laws, the employer must also comply

with state income and employment tax laws. Unlike the federal employment tax
procedures, many states impose quarterly filing requirements on household
employers.^^ In addition to the federal and state reporting requirements, the

47. See infra notes 96-97 and accompanying text.

48. Nantell, supra note 16, at 884.

49. See A NaniNet (visited Oct. 7, 1998) <http://www.4nannytaxes.coni/tips.htm>.

50. The social security tax on this amount is 6.29%. The Medicare tax is 1 .45%. See id.

5 1

.

See id.

52. See supra note 27 and accompanying text.

53. In California, for example, domestic employers must register with the Employment



1 1 96 INDIANA LAW REVIEW [Vol. 32:1187

Immigration and Naturalization Service ("INS") also imposes obligations on
household employers. The immigration status of a new employee must be
verified.^"* Once the employer verifies the worker's eligibility to work in the
United States, Form 1-9 must be completed and maintained in the employer's
records.^^

Passage ofthe Personal Responsibility and Work Opportunity Reconciliation
Act of 1996 (the "Reconciliation Act")^^ increased the burden on employers of
household employees. Under the Reconciliation Act, all employers are required
to report information on newly hired employees.^^ The purpose of the act is to
track the employment of non-custodial parents for purposes of collecting child
support.^^ All employers must comply with the federal requirements regardless
of the size or type of business. The Reconciliation Act requires a household
employer to report the nanny's name, address, social security number, date of
hire and date of birth. Certain employer information, such as name and address
must be provided as well.^^

C. Illegal Immigrant Workers

The proliferation of the immigrant workforce has spavmed a ground swell of
willing illegal immigrant child care providers. In certain areas of the country,

hiring an illegal immigrant child care provider is commonplace. Illegal

immigrant nannies are often referred to potential employers by legitimate

employment agencies when they do not have enough legal applicants to meet
employer demand.^° In major metropolitan areas, household employers lament

that the only domestic workers who are willing to work long hours for a
reasonable price are illegal immigrants.^^

Once an illegal immigrant worker is hired, there is little chance that the

Development Department ("EDD") within 15 days after paying cash wages of $750 or more in a

calendar quarter, and must hold and transmit to the EDD the employee's portion of the tax for state
disability. Household employers who pay cash wages of $1000 or more in a calendar quarter must

also pay the employer's portion ofthe unemployment insurance. See Russell S. Bick, 1999 Guide

To California Taxes 627-30 ( 1 999).
54. The Immigration Reform and Control Act of 1986, Pub. L. No. 99-603, 100 Stat. 3359

(1986) (codified at scattered sections of 8 U.S.C.).

55. 5ee 8 C.F.R. 274(a) (1994).

56. Pub. L. No. 104-193, 1 10 Stat. 2105 (1996) (codified at scattered sections of 8 U.S.C.

&42U.S.C.).

57. 42 U.S.C. § 653a(b) (Supp. II 1996).

58. See id. § 653(a).

59. See id. § 653a(b). Employers must provide this information to the State Directory of

New Hires. See id.
60. See Deborah Sontag, Increasing Two-Career Family Means Illegal Immigrant Help,

N.Y. Times, Jan. 24, 1993, at 1.

61

.

See id. Zoe Baird claimed that whenever she advertised for domestic service positions,

only illegal applicants responded. See id. r



1 999] PROTECTING CHILD CARE WORKERS 1 1 97

employer will pay the nanny tax. First, an employer who broke the law by hiring
an illegal immigrant is unlikely to comply with employment tax laws. Second,
the secrecy of the illegal employer/employee relationship precludes any

government interaction for fear ofthe worker's detection and deportation. Third,

completion of the IRS employment tax forms requires the employer to report the
employee's social security number." Without a legitimate social security

number, the employer is unable to pay employment taxes.

D. Women 's Work

The status given to home labor is inferior to the status given to other types
of wage labor in terms of financial status, security and recognition.^^ Despite
advances of women in the paid labor force, child care and housework are
perceived as marital obligations that rest with women. Tasks performed by
nanny's such as feeding babies and changing diapers have traditionally been

performed for free by women residing in the home.^
The delegation of child care to surrogate care takers continued the wage

inequality between domestics and other paid laborers.^^ The earliest household
workers were slaves and indentured servants, who cooked, cleaned, and cared for
children without financial remuneration. The turn of the century brought
immigrant women laborers who received below market wages for their services.
Child care has never achieved the status associated with other types of paid labor

in terms of earnings, status, and career advancement.^^

Domestic workers have failed to attain equal status under the law. The
reporting requirement for wages paid to household workers is higher than that for

62. Department of the Treas., I.R.S. 1998 Form Schedule H.

63. See Katharine Silbaugh, Turning Labor into Love: Housework and the Law, 91 Nw. U.

L. Rev. 1, 14-15 (1996) (discussing the legal treatment of women's unpaid wages).

64. See Kathryn Branch, Note, Are Women Worth As Much As Men? Employment Inequities,

Gender Roles, And Public Policy, 1 DUKE J. GENDER L. & POL'Y 1 19, 121 n.7 (1994). Use of the
term "working women" to denote women who work in the paid labor force versus in the home

illustrates the devaluation of unpaid labor performed at home. The author notes that work is work

and that women who work in the home work just as much as women who work outside—^the fact
that in-home workers are not financially compensated does not change the character of the labor

performed. Id

65. Id. at 138 n.70 (citing U.S. Bureau of the Census, Statistical Abstract of the

United States 426 & tbl. 671 (113th ed. 1993) [hereinafter 1993 Statistical Abstract]).
Professional child care is one of the lowest paying jobs in this country. See 1993 Statistical

Abstract, at 426, tbl. 67 1 . Truck drivers earn almost three times as much. See Branch, supra note

64,atl38n.72.

66. Women who spend a substantial amount of time in the unpaid work force worry that
their responsibilities as a homemaker will not translate into marketable skills that can be carried

over into the paid labor force. This is equally true for women who perform domestic service in the

paid labor force by providing household services to another family. See Silbaugh, supra note 63,

at 73.



1198 INDIANA LAW REVIEW [Vol. 32:1187

other workers, exempting more domestic workers from social security upon
retirement.^^ The National Labor Relations Act ("NLRA"/* excludes individuals
employed as domestic workers in private homes.^^ This exclusion denies
domestic workers the opportunity to organize under NLRA protections for
increased wages or benefits7°

Excluded from the Occupational Safety and Health Act ("OSHA")^'
definition of employer is an individual who, in their own residence, privately
employs a person to perform domestic tasks, such as caring for children/^ While

it may be argued that domestic employers employing an individual household
worker should not fall within the scope of the OSHA requirements, in other
contexts the term employer is interpreted broadly enough to include an employer
who only employs one employee. Most state worker's compensation statutes
also fail to protect domestic workers.^^

It is debatable whether the inferior status given to domestic work is
attributable to the value placed on the work performed, or the women workers
providing the services. The two, however, cannot be separated as cultural
devaluation of child care work relates both to the status given to housework and
gender inequities in employment in general. Domestic work remains primarily
women's work and women's work is notoriously under-paid.

^"^

Reliable in-home child care enables women to ftilfill the demands of
professional employment. Traditional gender roles envision the workaholic man
consumed by his career while his wife stays home to cook, clean and raise
children. Liberation from household chores and child care responsibilities allows

women to compete with men free from the same domestic obligations.
In dual-income families, the solution to the division of household labor

problems is often to hire another woman to perform these domestic functions for
very low pay.^^ Thus, the advancements made by professional women through

67. The earnings threshold for socied security coverage for household workers is $1000 per

year. See Social Security Domestic Employment Reform Act of 1994, Pub. L. No. 103-387, 108

Stat. 4071 (increasing the quarterly threshold of $50 to an annual threshold of $1000 exempting

more domestic workers from coverage under the act).

68. 29 U.S.C. §§ 141-97 (1994 & West 1998).
69. See id. §§ 141-42(1) (West 1998).

70. See id.

71. Id §§ 651-78 (1994 & Supp. II 1996).
72. Id. § 652 (1994). OSHA applies to employers who are "engaged in a business affecting

commerce." Id.

73

.

See 4 ARTHUR LARSON, THE Law of Workmen's Compensation ( 1 995). Only New

Hampshire applies worker's compensation statutes to all domestic workers. Twenty-three states

apply worker's compensation statutes within certain limited restrictions. The remaining states do

not apply worker's compensation statutes to domestic workers at all. See id.

74. See Awida R. Marquez, Comparable Worth and the Maryland Era, 47 Md. L. Rev.

1 129, 1 150 (1988) (arguing that jobs are undervalued because women hold them).

75. See RosANNA HERTZ, More Equal Than Others: WomenandMen in Dual-Career
Marriages 159(1 986).



1 999] PROTECTING CHILD CARE WORKERS 1 1 99

the assignment of child care duties have been made at the expense of women
without comparable professional skills or opportunities. When child care
responsibilities are given to an in-home child care provider, the woman of the
household typically functions as the house manager, dictating the hours and

terms ofemployment to the household worker7^ This means that improving the
working conditions associated with child care is dependent on women protecting
the rights of other women and recognizing the economic value of child rearing.

E. Crime and Punishment

The final, and most disturbing, reason for noncompliance is that many
taxpayers do not fear detection or retribution. They just do not think that they
will be caught. The tax system is based on taxpayer self-assessment, which is
reinforced by the threat of detection and prosecution.^^ It has been suggested that

absent these threats, taxpayers will cheat on their taxes when the opportunity is
present.^* It is undeniable that a taxpayer is more likely to pay a tax when it
cannot be avoided, such as when the tax is withheld from the taxpaying
employee's paycheck.^^ However, when a taxpayer is responsible for reporting
items of income, many receipts are likely not reported at all.^°

The payment of employment taxes is entirely dependent on taxpayer self-
assessment and reporting. The tax is not withheld from the employer's paycheck;

therefore, the tax is paid only when the household employer takes affirmative
steps to accurately report, assess, and pay the tax. Because the domestic

employment relationship occurs in the privacy of the taxpayer's home, the
government can never really know if the taxpayer is employing a household
worker, absent intrusive home surveillance devices. Even when the household
employer properly reports the employment relationship, the IRS must completely

rely on taxpayer self-assessment for the proper reporting of wages subject to the
tax.*^

76. See Branch, supra note 64, at 124. Branch states that

men's participation is that he "helps" with "her" housework; she hires and instructs the

cleaning woman and the baby-sitter. In other words, we have progressed to the point

where a woman is allowed to delegate her responsibilities in the home, but it is still

clearly her responsibility to make sure the children are cared for and the house is clean.

Id

77. See JOHN S. CARROLL, How Taxpayers Think About Their Taxes: Frames and
Values in Why People Pay Taxes 43 (Joel S. Slemrod ed., 1992).

78. See ERIC RiCE, THE CORPORATE TAX GAP: EVIDENCE ON TAX COMPLIANCE BY SMALL
Corporations in Why People Pay Taxes 125 (Joel Slemrod ed., 1992).

79. See Rosenberg, supra note 44 (reporting that compliance is higher only among wage

earners whose taxes are withheld at the source).

80. See id.

81

.

When the household employer pays the worker in cash, it is impossible for the IRS to

accurately assess the wages paid. Ofcourse, any statements by the employer and/or employee will

be completely self-serving and unreliable inasmuch as it is unrealistic to think that the employer



1200 INDIANA LAW REVIEW [Vol. 32:1187

The IRS has failed to diligently enforce the nanny tax provisions. Few cases
ofemployment tax evasion are prosecuted. While the IRS has threatened to step
up its enforcement efforts with few results, compliance with the nanny tax
provisions continues to decrease.^^

The INS has faced similar problems in the enforcement of employment laws.
In 1986, Congress passed the Immigration Reform and Control Act ("IRCA").*^
IRCA requires employers to verify an employee's eligibility to work in this
country and imposes fines and possible imprisonment on employers who
knowingly hire undocumented workers.*"* IRCA applies to all employers,
including those employers who employ individuals to work in private homes,
such as nannies.*^

Enforcement of IRCA has been limited to larger employers of low paid
service workers, such as restaurants, hotels, landscapers and cleaning services.*^

Although domestic employers who fail to comply with the law are at risk of
receiving minor fines if caught,*^ the INS has issued statements that the
provisions of IRCA will not be imposed against household employers, thereby
allowing the practice of hiring illegal workers to continue unabated.**

III. Private Failures/Public Burdens

Due to factors such as the number of full-time women professionals, an
increase in the number of American families earning more than $100,000 per
year, and the number of immigrants entering the United States, the number of
women employed as domestic workers should be on the rise.*^ In fact, quite the

would fail to pay the tax, the employee would fail to report the income, and they would be

completely truthful with the IRS.

82. See Patrice Apodaca, INS Preparingfor "Nanny Tax" Crackdown?, L.A. TIMES, Jan.

31, 1996, at D-6; Ben Wildavsky, More Calls to IRS About Domestic Employees; Zoe Baird Case

Raises Awareness, S.F. Chron., Jan. 23, 1993, at CIO (discussing an active investigation of only

50 cases in a major metropolitan area, which is indicative of how many non-compliance cases fall

through the cracks).

83. Pub. L. No. 99-603, 100 Stat. 3359 (1986) (codified at scattered sections of 8 U.S.C).

84. 8 U.S.C. § 1324a (1994 «& Supp. Ill 1997). The regulations provide that a person who

engages in a pattern or practice of violation ofthe Act shall be subject to fines of no more than $500

for each unauthorized worker, imprisonment for not more than 6 months, or both. 8 C.F.R. §

270.3(b) (1998).

85. Id

86. See Stanley Mailman, The Employer as Immigration Inspector, N.Y. L.J., Apr. 22, 1996,

at 3.

87. See id. In addition to receiving minor fines, high-profile employers may also receive

damaging publicity. See id.

88. See id.

89. See David Frum, Domestic Workers, CURRENT, May 1997, at 39. Frum reports that

roughly 15 million American women work as professionals and that an equal number of immigrants

have entered the country since 1970. Almost six million American households earn more tl^an



1 999] PROTECTING CHILD CARE WORKERS 1 20

1

opposite is occurring. As recently as 1972, nearly 1.5 million workers, virtually
all women, worked as domestic servants.^ Over the past twenty-five years these
numbers have collapsed. By 1983, less than a million workers were employed
as full-time domestics.^^ The Department of Labor projects that this shrinkage
is likely to continue with the number of women working as in-home, full-time
child care providers (a subdivision of the larger domestic worker category)

dropping from its current level of 350,000 to between 75,000 and 200,000 over

the next ten years.^^

Both legal and illegal workers are employed as child care providers.^^ This

is a distinction that often dictates the worker's salary, benefits, hours, and

working conditions. The competition to find and hire "qualified"^"* legal
domestic help has become fierce.^^ Salaries have skyrocketed, as have nannies'

$100,000 per year (twice as many as in 1980) and almost one million families earn more than

$200,000 per year. See id.

90. See id.

91. See id. Only 980,000 women worked as full-time domestics in 1983; only 820,000 in

1995. See id

92. See id.

93. See Delaney, supra note 1 5, at 3 10-1 1 . Falling within the legal classification of legal

child care providers, but outside of the "nanny tax" issues are au pairs. The Au Pair Exchange

Visitor Program allows young people, who are not domestics by vocation, to work temporarily in

the home of American host families. Au pairs receive free room and board as well as a salary of

approximately $100 per week from the host family. Employers using au pairs as child care

providers do not have to comply with the "nanny tax" provisions because services provided by au

pairs are not subject to PICA or FUTA withholding. See id.
See also Kathy Boccella, Nanny Shortage Reaches Crisis Point Qualified Caretakers Fetch

Top Dollar, Get "Posh" Jobs, TiMES-PlCAYUNE, Dec. 26, 1998, at R9. While using an au pair as

a nanny presents an alternative to costly legal, or illegal, employment, the publicity received

following the death of an eight-month-old baby while under the supervision of a British au pair,

Louise Woodward, has had a chilling effect on the hiring of au pairs. As a result of the case, the

number of au pairs plummeted, decreasing from a high of 1 1,000 in the mid 1990s to just 3000 in

1997. See id

94. I cannot say with certainty what "qualified" means. My opinion, which is purely
anecdotal, based on research for this Article and from what I have observed as a parent of a toddler

in a major metropolitan area, is that "qualified" means English proficient—^a buzz word for English
as a first language—having a driver's license, and some college education. Based on the
qualifications given, "qualified" nannies tend to be Anglo- or European-American. It is certainly

true that there is a distinction between working as a "nanny" and a "housekeeper" who also the

watches the children. I employ a worker from Central America as a "nanny" meaning her primary

obligation is to care for my child. However, she has been referred to by others as my "Girl" my
"Maid" and my "Housekeeper," but never as my "Nanny." I can only speculate that if she was bom
in Europe the nomenclature would be different.

95. See Boccella, supra note 93, at R9. One prospective household employer unsuccessftilly

attempted to lure a nanny by offering a salary of $500 per week, paid vacations and holidays,

overtime, use of a car, and tuition reimbursement. See id.



1202 INDIANA LAW REVIEW [Vol. 32: 1 1 87

demands. In major cities a fiill-time nanny receives a salary of about $400 per
week.^ For college-educated nannies that amount can exceed $1000 per week.^^
Once found, a competent, reliable, educated nanny is a coveted member of the
household to be retained at all costs. Nannies demand and receive perks such as
cars, mobile telephones, health care benefits, and paid vacations.^^ In this seller's

market, qualified nannies control the parameters of the employment relationship.
The picture is quite different for illegal immigrant child care workers and

those American workers who are considered less "qualified." In-home child care
providers are unprotected by labor laws.^ Domestic workers are denied the
opportunity to organize, leaving employers with the power to dictate the rates of
pay, working hours, and other terms of employment.^°*^ The relationship between
household employers and employees transpires behind closed doors, facilitating

exploitation. This is particularly true with respect to live-in nannies. Live-in

nannies may be required to work longer hours. Further, the conditions of their
employment may be ill-defined because the employee is in the home and
continuously available to the employer.

For illegal immigrant nannies, the balance of power weighs even more
heavily in favor of the employer.^^' Immigration status restricts job mobility

making illegal immigrant child care providers more dependent on employers.
Illegal immigrant nannies may feel powerless to question the terms of their
employment for fear of employer retribution. Illegal immigrant workers are
unable to utilize governmental agencies to enforce their legal rights. Fear ofINS
detection isolates illegal immigrant workers from other household employees.

*^^

The high cost of hiring a college educated, English-speaking child care
provider has left many families looking for a less skilled replacement. The
economics ofdomestic work and the creation ofan underground domestic service
market has attracted a legal as well as illegal immigrant work force.^^^ This has
changed the complexion of domestic help. Twenty years ago domestic service
was a black woman's job with nearly forty percent of domestic workers being
African American.*^ In 1995, fewer than seventeen percent of domestic workers

were African American.^^^ The thriving illegal child care market depresses

96. See id.

97. See id.

98. See id. A survey conducted by the Nanny News found that nearly all nannies got paid
vacations and holidays, over half got paid sick days, many received health insurance, and several

received other perks such as cash bonuses and club memberships. See id.

99. See supra note 68 and accompanying text.

100. Silbaugh, supra note 63, at 72.

101. See generally Peter Marguilies, Stranger and Afraid: Undocumented Workers and

Federal Employment Law, 38 DePaul L. Rev. 553, 533-34 (1989).

102. Id

103. See infra note 123 on the number of immigrants working as child care providers.

104. See Frum, supra note 89.

105. See id. This trend can be attributed to a number of factors: African American women

no longer want to do the work, employer prejudice in hiring household workers and "white guilt"



1 999] PROTECTING CHILD CARE WORKERS 1 203

wages and benefits for all but a few domestic workers. These economic and
cultural trends have stigmatized domestic work, encouraging unskilled American

workers to take other jobs even if they pay less.'^

Many nannies acquiesce in their employer's evasion of the tax laws. Illegal
immigrant workers, fearful ofINS detection, cannot establish a legal employment
relationship for purposes of paying the tax; therefore they only receive wages

under the table. Low-paid legal workers prefer to work illegally to increase the
net amount oftheir take home pay. Other household workers feel powerless in
the employment situation. Unable to enforce their legal rights, they accept the

terms ofemployment as offered by the employer. Because it is common practice
for domestic employers not to pay or to withhold employment taxes, an
employee seeking legal employment is restricted to fewer positions.

Working underground is not without its long term costs to domestic
employees. Social security payments are made based on PICA contributions
from the employer and deductions from the employee's paycheck. ^^^ If the

employer fails to pay employment taxes, the employee may not be entitled to
receive social security payments upon retirement. Without payment ofthe FUTA
premiums, the employee will not be entitled to federal unemployment payments
either.

^°^ Additionally, failure to comply with the state employment tax
requirements disqualifies the child care provider from receiving state

unemployment and disability compensation.*^^
Illegal employees are also excluded from other entitlements associated with

the wage labor market. Illegal employees have no verifiable wages, making it
virtually impossible to qualify for a mortgage, rent an apartment, or finance an

automobile. Illegal workers have no work history to transition into other types
ofemployment. A domestic worker may receive a letter of recommendation to
secure other domestic work, but not work in a legal wage market. The inability
to establish credit, access traditional financial services, and transition into other

wage labor markets restricts upward economic mobility, thereby reinforcing the
"servant" underclass.

The short-term benefit of avoiding employment and income taxes may not
be worth the long-term price."^ The income tax system is being used to deliver

over perpetuating black servitude. See id.

106. This applies to uneducated and unskilled workers. College educated nannies are heavily

in demand, receiving high salary and benefits. See supra notes 96-98 and accompanying text.

107. See I.R.C. §§ 3101, 3201, 3221 (1994 & Supp. II 1996 & West Supp. 1998).
1 08. The Federal Unemployment Tax Act ("FUTA") originally exempted domestic workers.

Congress amended FUTA to cover domestic employees earning more than $1000 per quarter. See
Deborah Maranville, Changing Economy, Changing Lives: Unemployment Insurance and the

Contingent WorJrforce, 4 B.U. PUB. iNT. L.J. 291, 301 (1994).

109. See id.

1 10. Assuming an average salary of $14,000 for a single full-time child care provider the

employment tax liability would be $1071 and the federal income tax liability as high as $1057.50,

assuming a standard deduction of $4250, personal exemption of $2700 and a 15% tax rate.



1 204 INDIANA LAW REVIEW [Vol. 32:1187

substantial work-related federal income transfers to employees.* ^^ Federal tax
subsidies, such as the earned income credit, increase employee cash wages in
excess of federal tax liability.**^ The earned income credit is a federal tax
subsidy, which can only be received by workers who report items of income by
filing an income tax return.**^

The earned income credit is a refundable income tax credit provided to
qualified workers at a low to moderate income level."'* The credit was
established to encourage work by supplementing employee wages and offsetting
the increasing cost of living and social security taxes. To receive the credit the
employee must file an income tax return. If the employee is eligible, the
employer may make the advanced earned income credit payment directly to the
employee each pay period.**^

An employee is eligible to receive the credit if the employee earned less than
$25,760 and has at least one qualifying child living in the same household or if
the employee earned less than $29,290 and had more than one qualifying child
living in the same household."^ Employees without a qualifying child may still
receive the credit if they earned less than $9770."^ For nannies whose salaries
hover around minimum wage, receipt of the earned income credit increases the
employee's net "take home" pay. However, many domestic workers unfamiliar
with the income tax system may not be aware of this federal tax subsidy.

Noncompliance with the nanny tax requirements has cost employers as well,

because federal child care subsidies are delivered through the tax code. Federal

child care subsidies include the dependent child care credit, as well as employer

dependent care assistance programs."^ To receive these subsidies, the taxpayer

111. See Mary L. Heen, Welfare Reform, Child Care Costs, and Taxes: Delivering Increased

Work-Related Child Care Benefits to Low-Income Families, 13 YALE L. & POL'Y REV. 173, 175
(1995) (noting that one example of the integration of the tax and income transfers systems is the

expansion of the refundable earned income tax credit).

112. See infra notes 113-17 and accompanying text for a discussion ofthe benefits paid under

the earned income credit.

113. The earned income credit reduces the amount of taxes the employee owes and may

provide a reftind in excess oftax liability. The credit is received by completing IRS Form W-5 and

Line 59 on Form 1040.

1 14. IRC § 32 allows a refundable credit against the income tax. I.R.C. § 32 (1994 & Supp.
II 1996).

115. An employee is eligible to receive advanced earned income credit payments if the

following three conditions are met: (1) the employee has at least one qualifying child; (2) the

employee expects that her 1999 earned income and modified adjusted gross income will each be

less than $26,928, including spousal income if the employee plans to file a joint return; and (3) the

employee expects to be able to claim the earned income credit in the applicable year. See

Department of the Treas., I.R.S. 1998 Form W-5.

116. 5ee I.R.C. § 32.

117. See id

118. See infra notes 132-37 and accompanying text for a discussion of dependent care

assistance programs.
,



1 999] PROTECTING CHILD CARE WORKERS 1 205

must provide child care provider information, such as the name, social security

number, and address of the child care provider.^ *^ Receipt of the currently

available federal tax subsidies, while not enough to encourage employer

compliance, can alleviate part of the burden associated with paying the tax.

The federal revenue lost by domestic workers' unreported income results
from billions ofdollars in unreported payments for child care.^^° Depletion ofthe

federal income tax base is not the only cost of unreported domestic service

income; the ultimate burden for providing for individuals unable to provide for

themselves and their families is borne by society at large. Without social

security, disability, and unemployment compensation, domestic workers are more
susceptible to dependence on other government programs such as welfare if they

become sick or lose their jobs. ^^^

IV. Models FOR Reform

It is impossible, absent extreme punitive measures such as intruding on the

privacy ofthe employer's home, and coordination between federal agencies such

as the INS and the IRS, for the government to deter the hiring of illegal domestic
workers. Reform must come through encouraging taxpayers to voluntarily
comply with the employment tax laws.

Compliance can be increased by attacking three fronts: enforcement,

information, and incentives. It is only when household employers receive
incentives, fear retribution, and are informed of how to comply with the law that
any increase in the voluntary payment of employment taxes will occur.

A. Enforcement

Enforcement ofthe nanny tax provisions provides the best weapon to combat
evasion ofthe employment taxes by household employers. To enforce the law,
taxpayers subject to the tax must be identified and stiff penalties must be

imposed. Despite the flagrant flouting of the law by household employers and

the publicity surrounding the issue in recent years, there has been very little

enforcement of the nanny tax provisions. The IRS has suggested more diligent
enforcement of the nanny tax provisions for some time with few results.

Enforcement of the nanny tax provisions is easier than enforcing other IRC

119. Taxpayers who want to take the dependent Child Care Credit or receive employer

provided child care benefits must complete Form 2441 . The form requires the taxpayer to furnish

the providers name, address, social security number and the amount paid. Department of the Treas.,

I.R.S. Form 2441.

120. See Larry Tumell et al., Nannygate: An Overview Of Payroll Tax Rules and

Immigration Laws, J. ACCT., July 1993, at 36.

121. These workers are often immigrants. In California, the percentage of immigrant child

care workers has jumped from 20% in 1980 to 56% in 1996. See Patrick J. McDonnell, Jobs Exist

for Immigrants, Study Finds Labor: Report Says Unskilled New Arrivals Are "Structurally

Embedded" in the Economy, Including Growing High Tech Sector, L.A. TIMES, May 4, 1998, at
Bl.



1206 INDIANA LAW REVIEW [Vol. 32:1187

provisions because many taxpayers with dependent children are a self-identifying
group. Taxpayers with dependent children are entitled to a dependency
exemption. ^^^ For taxpayers taking the exemption, the age, name, and social
security number of the dependent child must be provided on a taxpayer's return.

The review of dependency information provides a valuable tool in enforcing
the nanny tax provisions. The IRS can identify returns that list young children,
particularly children who are not yet of school age. These returns can be further
examined to determine if both parents work outside the home. Other factors can
be reviewed based on information contained in the returns, such as gross income
and the deduction of expenses paid to child care providers. Collecting this
information allows the IRS to trigger certain returns for further review.

Dependency information review will not capture all nanny tax evaders.
Taxpayers whose adjusted gross income exceeds certain threshold amounts will
be unable to take the deduction. ^^^ These high-income taxpayers do not provide

dependency information on their returns. Unfortunately, it is taxpayers whose
income exceeds the dependency exemption thresholds that are more likely to use
in-home child care. Requiring all taxpayers with dependents under a certain age

to list the names, ages, and social security numbers of any dependents would
allow the IRS to fairly evaluate the returns of all taxpayers who may be
employing a nanny.

Changing reporting requirements for payment ofthe nanny tax can also aid
in enforcement. Currently, certain wages are exempt for purposes of paying the

tax. Exempt wages include wages paid to teenage baby-sitters, other household
workers under the age of eighteen, wages under $1200 paid for the calendar year,

and wages paid to certain family members. Wages paid to au pairs are also not
subject to the nanny tax requirements.^^"* Employers hiring family members and
au pairs should be required to file an informational return listing the name,

address ofthe child care provider, and the wages paid for the year. This can help

the service in weeding out taxpayers that are not required to pay the tax.

Nanny taxes are currently reported on Line 55 of the 1040 individual tax
form.^^^ Line 55 requires the amount owed for social security and Medicare
taxes for household employees. A taxpayer who fails to accurately assess and
report taxes owed on their Form 1040 is declaring under penalty of perjury that
she did not employ a household employee during the tax year. Taxpayers who
fail to pay income taxes owed are subject to interest and penalties on the amount

122. IRC § 151 allows a personal deduction (exemption) in calculating taxable income, with

an additional exemption for each dependent. I.R.C. § 151 (West Supp. 1998). IRC § 152 defines

a "dependent" to include a child of the taxpayer's over half ofwhose support was received from the

taxpayer. I.R.C. § 152.

1 23

.

IRC § 1 5 1 (d)( 13) provides that any adjusted gross income that exceeds the threshold

amount shall be reduced by two percentage points for each $2500 by which the taxpayer's adjusted

gross income exceeds the threshold amount for 1998. I.R.C. § 151(d)(13).

124. I.R.C. § 3121(b)(21) (as amended by § 2(a)(1)(C) of the Social Security Domestic

Employment Reform Act, Pub. L. No. 103-387, 103d Cong, 2d Sess. (1994)).

125. Department of the Treas., I.R.S. 1998 Form 1040, Line 55.



1 999] PROTECTING CHILD CARE WORKERS 1 207

of the deficiency. '^^ These penalties apply to taxpayers who fail to pay
employment taxes, which are required to be reported on the employer's tax
return. ^^^ A penalty is imposed on a taxpayer who without reasonable cause fails
to pay tax.'^^ An accuracy-related penalty is imposed ifthe understatement is due
to negligence. '^^ Fraudulent underpayment ofa tax required to be reported on the

return may result in the imposition of a seventy-five percent penalty.'^"130

B. Information

Information must be given to household employers, as well as their tax

preparers. Many taxpayers who are overwhelmed by paying taxes on wages and
other items of income refuse to pay an additional tax. Household employers who
prepare their own tax returns may be unable to grasp the complications of paying
employment taxes. While there are services that will do this for household
employers, these services are expensive.

Household employers must be given information on ways to reduce the
federal tax burden that comes along with hiring legal child care providers and
complying with employment tax provisions. The child care tax credit provides
a federal tax rebate that is available to defray at least part of the nanny tax

expense. To receive the credit, the taxpayer must verify the amount of the
expense and identify the child care provider.'^* A second federal tax subsidy,
which provides tax-free income to pay child care expenses, is the dependent care

assistance program.*^^ This program authorizes employers to provide employees

with tax-free dependent care assistance.^"

126. 5eeLR.C.§ 6601(g).

1 27. Following the nanny tax scandal, Zoe Baird paid $10,900 in taxes, interest penalties, and

fines. See Robert L. Turner, Cough Up, Counselor, BOSTON GLOBE, Feb. 11, 1993, at 23.

1 28. IRC § 665 1 (a)(2) provides that a penalty is imposed when a taxpayer, without reasonable

cause, fails to pay the tax. The penalty is 0.5% of the tax assessed each month until the tax is paid.

The maximum amount of the penalty is 25%. I.R.C. § 6651(a)(2).

129. IRC § 6662(b) provides that the accuracy-related penalty is imposed if any part of the

underpayment is due to negligence or disregard for the rules without the intent to defraud. I.R.C.

§ 6662(b).

130. 5ee I.R.C. § 6663(a).

131. See supra note 1 1 9 and accompanying text.

132. IRC § 129(a)(1) provides that the gross income of an employee does not include

amounts paid or incurred by employers for dependent care assistance provided to employees. I.R.C.

§ 129(a)(1). See also Economic Recovery Tax Act, Pub. L. No. 97-34, § 124(e), 95 Stat. 198-201

(1981) (codified at 26 U.S.C. § 129 (1994 & Supp. II 1996)).
133. IRC section 129(d)(1) describes a dependent care assistance program as a separate

written plan of the employer for the exclusive benefit of his employees to provide them with

dependent care, which meets the following requirements: (1) Discrimination—^The contributions
or benefits provided under the plan do not discriminate in favor of highly compensated employees;

(2) Eligibility—The program benefits a classification of employees set up by the employer that is
found by the Secretary of the Treasury to be non-discriminatory; (3) Principal shareholders or



1208 INDIANA LAW REVIEW [Vol. 32:1 187

Many dependent care assistance programs are implemented through a salary
reduction plan, which costs the employer nothing, but allows the employee to
deduct the amount of dependent child care expenses from her gross income and
seek reimbursement from the plan for the child care expenses when they are
incurred.

^^'* When seeking reimbursement for child care expenses, the employee
must provide the employer with the child care provider's name, address, and
social security number.'^^ Technically, these reporting requirements should

restrict receipt of child care credit and dependant care assistance benefits to

taxpayers who employ legal nannies.
Employees participating in an employer-provided dependent care salary

reduction program may exclude from income taxation up to $5000 oftheir wages
to pay for child care expenses. *^^ The $5000 is a deduction from income,
allowing wealthier taxpayers to receive a larger tax subsidy. Taxpayers

participating in a dependent care assistance program whose income is taxed in
the highest marginal tax rate will receive a child care subsidy of approximately
$2000,^^^ an amount that would cover all, or at least a significant portion of, the

nanny tax.

Household employees must also be informed of their employment rights.

owners—Not more than 25% of the amounts paid or incurred by the employer during the year are
provided for shareholder or owners each ofwhom owns more than five percent of the stock or the
capital or profit interests of the employer; (4) Notification of eligible employees—^The employer
provides reasonable notification ofthe availability and terms of the program to eligible employees;

(5) Statement of expenses—^The plan fumishes to an employee a written statement of amounts paid
or incurred by the employer in providing dependent care assistance to the employee; (6)

Benefits—^The average benefits to employees who are not highly compensated under all employer
plans are at least 55% ofthe average benefits provided to highly compensated employees under all

employer plans. Additionally, in the case of benefits provided under a salary reduction agreement,

the plan may disregard employees whose compensation is less than $25,000; (7) Excluded

employees—^The following employees may be excluded from the eligibility and benefits
considerations: (A) Employees who have not attained the age of 21 or completed one year of

service (as defined in IRC § 410(a)(3)), and (B) Employees who are not covered in the program

who are covered by a collective bargaining agreement between employee representatives and one

or more employees, if it is found that dependent care benefits were the subject of good faith

bargaining; (8) The program is not required to be funded. I.R.C. § 129(d)(1).

1 34. See BLANKAND WILLIAMS, CHILD CARE: WHOSE PRIORITY? A STATE CHILD CARE FACT
Book 16 (1985).

135. IRC § 21(e)(9) requires the tax payer to provide this information with respect to a

service provider to receive dependent care credit. I.R.C. § 21(e)(9) (1994).

136. IRC § 129(a)(2) provides that the amount, which may be excluded for dependent care

assistance, shall not exceed $5000 ($2500 in the case of a separate return filed by a married

individual). I.R.C. § 129(a)(2) (West Supp. 1998).

137. The highest marginal tax rate imposed by IRC § 1 is 39.6% and is imposed on taxable

income over $250,000 for married individuals filing joint returns, heads of households, and

unmarried individuals, and on taxable income over $125,000 for married individuals filing separate

returns. I.R.C. § 1.



1 999] PROTECTING CHILD CARE WORKERS 1 209

Domestic employees may be unaware that their employers are required to pay
employment taxes on their behalf. Household employees must be provided with
information on the benefits associated with legal employment, such as eligibility

for social security and unemployment benefits. Household employees must also

be informed oftheir eligibility to receive the earned income credit. Absent this

information, workers are less likely to demand the establishment of a legal
employment relationship.

IV. Proposals For Change

Although limited child care credits have been permitted under the IRC, a full

deduction for child care expenses has been rejected. ^^^ Child care has been

considered indistinguishable from other nondeductible personal expenses such

as food, clothing, and shelter. When an individual taxpayer is allowed to deduct
personal expenses, the integrity of the income tax system is threatened, because

the government is paying for part of the taxpayer's consumption while others,

who are unable to take the deduction, pay the entire cost.'^^ However, tax
incentives are provided to encourage taxpayer consumption in particular areas.

The classic example is the deduction ofhome mortgage interest.'''^ Homeowners
receive a federal tax rebate of a portion oftheir personal living expenses,^"*^ while

renters do not. The efficient implementation of social policy has traditionally
justified the vertical inequities created by tax expenditures. Inadequacies in

encouraging nanny tax compliance support a deduction for salary paid to in-home

child care providers in the current child and dependent care credit.

Household employer compliance with the federal employment tax laws may
chill the hiring of illegal immigrant child care providers. This is not the intended

138. See infra Parts IV.B.1-2 for a discussion of the deductibility of child care expenses.

1 39. See Wendy Gerzog Shaller, Limit Deductionsfor Mixed Personal/Business Expenses:

Curb Current Abuses and Restore Some Progressivity into the Tax Code, 41 Cath. U. L. Rev. 581

(1992).

140. From its adoption in 1913, the federal income tax has always contained a deduction for

personal residence interest paid by a taxpayer. The deduction of home mortgage interest is one of

the oldest tax expenditures in the IRC. The legislative purposes in granting the expenditure is

unclear. See TAX BREAKS: An INTRODUCTION TO TAX EXPENDITURES (W. Barnes ed., 1985).
141. IRC § 163(h) permits the deduction of qualified home residence interest. Qualified

home residence interest means interest on a mortgage to acquire or substantially improve the

taxpayer's principal residence and one other residence. The maximum mortgage amount on which

interest is deductible is one million dollars. Section 163 also permits the deduction of home equity

interest when there is adequate equity in the property and the promissory note is secured by the

taxpayer's property. The maximum loan amount on which interest may be deductible as home

equity interest is $100,000. However, unlike acquisition indebtedness, the proceeds of a home

equity loan do not have to be used to improve the property and can be used for any taxpayer

purpose. If taxpayer A purchases a Mercedes 500SL for $100,000, which is financed with the
proceeds of a home equity loan, the interest will be deductible while taxpayer B who uses dealer
financing will be unable to deduct the interest on the loan. I.R.C. § 163.



1210 INDIANA LAW REVIEW [Vol. 32:1187

result. The proposals are suggested to improve the working conditions for all
domestic employees, legal and illegal. If a critical need for child care providers

exists, other policies must be implemented to enable families to employ
undocumented workers.*"*^

A. The Child Care Credit

Historically, child care costs have been treated as inherently personal,

nondeductible expenses. This is the result even in the case of two-earner

families, where child care is necessary for the production of income.'"^^ In 1954

a limited deduction^"*^ for child and dependent care expenses was added to the
IRC.^"*^ The child care deduction could be taken when the woman caretaker of
the family was either working or seeking employment.'"*^ In 1964, the deduction
was expanded to include husbands whose wives were incapacitated or
institutionalized.'^^ In 1976, the child care deduction was replaced by a child
care credit.'"** The amount of the child care credit has varied since 1976;'"*^

however, a child care credit, rather than a deduction, has been retained since that

time.'^'

IRC § 21 provides the current credit for employment related household and

142. See generally Delaney, supra note 15. One policy is relaxation of the immigration laws

to permit parents to hire nonresident child care providers. See id. at 3 17-26.

143. See Smith v. Commissioner of Internal Revenue, 40 B.T.A. 1038 (1939), aff'd per

curiam, 1 13 F.2d 1 14 (2d Cir. 1940).

144. The maximum amount deductible under IRC § 214 was $600, regardless of the number

of eligible children. If the child care provider also performed other household duties, the child care

expenses had to be prorated. See S. Rep. No. 83-1622, at 220 (1954).

145. Section 214 allowed an itemized deduction for the costs of caring for a child under the

age of twelve. I.R.C. § 214 (1954). The deduction also applied to physically or mentally

incapacitated dependents. See S. Rep. No. 83-1622, at 36 (1954); H.R. Rep. No. 83-1337, at 30

(1954). The expenses were limited to employment related child care expenses. Expenses were

considered to be employment related only if they were incurred to enable the taxpayer to be

employed. Therefore, the taxpayer had to be gainfully employed or actively searching employment.

See Treas. Reg. § 1.214A-l(c)(l)(i) (1954).

146. See Stanfield, supra note 4, at 220.

147. See The Revenue Act of 1964, Pub. L. No. 88-272, § 212(a), 78 Stat. 19, 49 (1964).

148. See Tax Reform Act of 1976, 1.R.C. § 44(a), Pub. L. No. 94-455, § 504, 90 Stat. 1520,

1563-66(1976).

149. The Economic Recovery Tax Act of 1976 increased the amount of the credit. Pub. L.

No. 97-34, § 124, 95 Stat. 172, 197-201 (1981). The Tax Reform Act of 1984 renumbered the

credit to IRC § 21. Pub. L. No. 98-369, §§ 471, 474, 98 Stat. 494, 825-26, 830-47 (1984).

1 50. As a credit, there is a dollar for dollar reduction in the tax owed. Therefore, the amount

ofthe creditable child care expense is not affected by the taxpayer's tax bracket. Also, the amount

is refunded without regard to whether the taxpayer itemizes or takes the standard deduction. See

I.R.C. § 21 (West Supp. 1998).



1 999] PROTECTING CHILD CARE WORKERS 1211

dependent care expenses. ^^' The credit is allowed for dependent child care
expenses, which are necessary for employment for taxpayers who maintain a
household, which includes a dependent under the age ofthirteen, or a dependent

or spouse of the taxpayer who is physically or mentally incapable of caring for
himself. ^^^ The creditable amount is a percentage of the employment related
dependent care expenses paid by the taxpayer during the taxable year.*^^ The
percentage is thirty percent, reduced by one percentage point for each $2000 that

the taxpayer's adjusted gross income exceeds $10,000.'^'* However, the

percentage cannot be reduced below twenty. ^^^ The maximum amount of
employment related expenses that may be considered for the credit cannot exceed
$2400 for one qualifying individual and $4800 for two or more qualifying
individuals.

^^^

The child care credit is one way the federal government attempts to assist
working families defray the costs of child care. The child care credit is the
largest federal child care subsidy. ^^^ Middle class taxpayers—individuals whose

151. IRC § 21 allows the deduction of employment related dependent care expenses.

Employment related expenses means amounts paid for expenses for household services and the care

of a qualifying individual, but only if such expenses are incurred to enable the taxpayer to be

gainfully employed for any period for which there are one or more qualifying individuals with

respect to such taxpayer. I.R.C. § 21(b)(2).

1 52. Only employment related expenses for the care of qualifying individuals are creditable.

IRC § 21(b)(1) defines a "qualifying individual" as:

(A) a dependent of the taxpayer who is under the age of 13 and with respect to whom
the taxpayer is entitled to a deduction under section 151(c),

(B) a dependent of the taxpayer who is physically or mentally incapable of caring for

himself, or

(C) the spouse of the taxpayer, if he is physically or mentally incapable of caring for

himself

I.R.C. § 21(b)(1). IRC section 21(b)(2) defines "employment-related expenses" as:

amounts paid for the following expenses, but only if such expenses are incurred to

enable the taxpayer to be gainfully employed for any period for which there are 1 or

more qualifying individuals with respect to the taxpayer:

(i) expenses for household services, and

(ii) expenses for the care of a qualifying individual.

Such term shall not include any amount paid for services outside the taxpayer's

household at a camp where the qualifying individual stays overnight.

Id. § 21(b)(2).

153. IRC § 21(a)(1) provides that "in the case of an individual who maintains a household

which includes as a member one or more qualifying individuals . . . there shall be allowed as a

credit ... an amount equal to the applicable percentage of the employment-related expenses . .

.

paid by such individual during the taxable year." I.R.C. § 21(a)(1).

154. 5eeI.R.C.§ 21(a)(2).

155. See id.

156. IRC § 21(c) provides dollar limitations on the creditable amount. I.R.C. § 21(c).

157. Nantell, supra note 16, at 909. In 1993, a $2.5 billion IRC § 21 child care and



1212 INDIANA LAW REVIEW [Vol. 32:1187

taxable income is between $20,000 to $50,000 per year—^who have two
qualifying dependents are the primary beneficiaries of this federal tax subsidy.

The child care credit is a non-refundable tax credit, meaning that the taxpayer
may not take the credit if the creditable amount exceeds the taxpayer's income
tax liability. The result is that the poor, taxpayers whose income is below the
amount required to file a return, receive no federal tax child care subsidy at all
because the amount of the credit exceeds their income tax liability. The
inadequacies of the dependent and child care credit in assisting very poor

families in paying for child care is a criticism expressed by commentators who
believe the credit should be used to deliver child care services to the poor.*^*

In the context of domestic service and payment of employment taxes, the
current child care credit is an inadequate incentive to encourage household

employees to comply with the nanny tax requirements. First, and foremost, the
carrot is just not sweet enough. The adjusted gross income of an employer
employing a full-time legal nanny is likely to exceed $30,000. For taxpayers
with adjusted gross income that exceeds that amount, the credit is restricted to
$480 (twenty percent of $2400) if they have one qualifying dependent or $960
(twenty percent of $4800) if they have two qualifying dependents.'^^ The
maximum credit amount is a fraction of what it costs a household employer to
comply with the nanny tax provisions.^^°

The current child care credit, if increased, could stimulate nanny tax
compliance by providing a greater incentive to use legal child care. The
creditable amount has not been adjusted for inflation since 1982, causing a forty-

five percent decrease in the credit's actual value. ^^^ Adjustments to the credit for

dependent tax credit was given to over 600 million families,

158. See Nantell, supra note 16, at 937, 939-41 (noting the short-coming of a non-refundable

child care credit); see also Jonathan Barry Forman, Beyond President Bush 's Child Care Tax Credit

Proposal: Towards a Comprehensive System ofTax Credits to Help Low-Income Families with

Children, 38 EMORY L.J. 661 (1989) [hereinafter Beyond President Bush 's Child Care Tax Credit

Proposal^, Jonathan Barry Forman, Using Refundable Tax Credits to Help Low-Income Families,

35 LOY.L. REV. 117(1989).

1 59. The amount of the credit has not even been increased to pace with rising employment

costs. The applicable child care credit amount is calculated by multiplying the creditable

employment related expenses by the applicable percentage. The percentage is phased down one

point for each $2000 by which the taxpayer's adjusted gross income exceeds $10,000. See supra

note 154 and accompanying text. Neither the applicable credit amounts nor the phase-down

schedule are indexed for inflation and have not been increased since 1982. See Beyond President

Bush 's Child Care Tax Credit Proposal, supra note 1 58, at 66 1

.

160. See Nantell, supra note 16, at 942. Professor Nantell provides the following

illustration: A taxpayer paying $1000 per month for in-home child care would owe an additional
$918 in nanny taxes for those wages. If the taxpayer only had one qualifying child, and adjusted

gross income in excess of $30,000, the maximum allowable child care credit would amount to only

$480. See id.

161. See id. at 938 (citing A.B.A. Sec. on Tax'n, Report ofthe Child Care Credit Task Force,

46 Tax Notes 331 (Jan. 15, 1990)).



1 999] PROTECTING CHILD CARE WORKERS 1213

inflation would ensure that it keeps pace with the increased cost of all types of

child care, including the salary of in-home child care providers. Apart from

increasing the creditable amount, loopholes must be closed to prevent taxpayers

who employ illegal workers from taking the credit.^"
One suggested solution, increasing the dependent and child care credit

available for household employers, is inefficient in promoting the payment of
employment taxes for a number of reasons. First, as a dollar for dollar reduction

ofthe employers tax liability, the difficulties of adjusting the credit to correspond

with the salary paid to a domestic worker prevents the use of a credit to offset

this expense. Second, a credit for employment taxes paid on behalf of a
household employee permits a tax rebate for taxes owed. Third, any attempt to

increase the child care credit to employers of private nannies will be rejected as

another attempt to provide tax relief to the rich.

B. Rethinking the Salary Deductionfor In-Home Child Care Workers

This section addresses two issues: First, the deduction ofchild care expenses

as an ordinary and necessary business expense for working parents, and second,

the disallowance of a salary deduction for wages paid to child care employees.
1. Child Care as an Ordinary andNecessary Business Expense?—^The IRC

grants priority to the deduction of business expenses,^^^ permits the deduction of

expenses related to income-producing activities within restrictive limitations,^^

and disallows many personal deductions^^^ that are unrelated to a trade or

162. See David Cay Johnston, Despite an Easing ofthe Rules, Millions Evade "Nanny Tax,
"

N.Y. Times, Apr. 5, 1998, at 1 (noting that tax payers have figured out ways to get a double benefit

by evading the nanny tax requirements while still talking the child care credit).

1 63. Employer business expense deductions are subtracted from gross income in determining

adjusted gross income, and as such are taken above the line. Deductions taken above the line are

not subject to the two percent floor requirements of IRC § 67. I.R.C. § 67 (West Supp. 1998).

Above the line deductions are also not subject to reduction under the overall limitation of itemized

deduction rules in § 68. I.R.C. § 68. IRC § 62(a)(1) provides that deductions, which are

attributable to a trade or business carried on by the taxpayer, are deductible from gross income if

the trade or business does not consist of the taxpayer's performance of services as an employee.

I.R.C. § 62(a)(1). Unreimbursed employee expenses are given a lower priority and are deductible

as miscellaneous itemized deductions to the extent that they exceed two percent of adjusted gross

income. I.R.C. § 67.

164. IRC § 212 allows a deduction for expenses associated with the production of income,

the management, conservation, or maintenance of property held for the production of income, as

well as expenses paid in the determination of any tax. I.R.C. § 212. IRC § 62(a)(4) provides that

§ 212 expenses related to the rental of real property may be deducted above the line. All

other § 212 expenses are deductible below the line as miscellaneous itemized deductions.

Therefore, deductions for income-producing expenses unrelated to rental activity are deductible

only to the extent that they exceed two percent of the taxpayer's adjusted gross income. I.R.C. §

67(a). Section 212 deductions are itemized deductions that are reduced under IRC § 68.

1 65. Expenses are purely personal when they are unrelated to carrying on a trade or business



1214 INDIANA LAW REVIEW [Vol. 32: 1 1 87

business or the production of income. The line between business and personal
does not always shine bright. Some expenses directly related to the generation
of income are allowed despite the fact that they cross the personal line. For
example, commuting expenses between a taxpayer's home and office are
nondeductible personal expenses, while commuting costs for travel between two
jobs are deductible because they are required by the exigencies of business. ^^

A deduction is allowed when a client is taken to lunch, but not when one is
dining with a colleague.

^^^

Child care has never been considered a deductible cost of doing business.

In 1940, the federal courts first considered the deductibility of child care

expenses in Smith v. Commissioner ofInternal Revenue}^^ In the Smith case, the

taxpayers attempted to deduct the expenses of hiring a child care provider after

Mrs. Smith, who had previously worked inside the home, re-entered the paid
labor force. ^^^ The taxpayers argued that the child care expenses were ordinary
and necessary business expenses. ^^° The Board of Tax Appeals held that the
child care expenses were not ordinary and necessary business expenses and

denied the deduction. ^^^ The Smith case exemplifies the sharp divide between tax
deductions for personal, business, and income-producing activities. Following

the Smith case, a limited federal tax deduction was allowed, prior to 1974, for
dependent care, which enabled the taxpayer to work. However, in 1975, the

deduction was replaced by the current tax credit.
^^^

or the production of income. Personal, living, and family expenses are generally non-deductible.

See I.R.C. § 262(a). Deductions are allowed for some narrowly defined, purely personal items.

See, for example, IRC § 163(h), which allows the deduction of qualified residence interest, IRC

§ 164(a)(1), which allows the deduction of state, local and foreign real property taxes, and IRC §
213, which allows the deduction of expenses for medical care. However, the deduction of these

items may be limited. For example, only extraordinary medical expenses are deductible. IRC §
213(a) provides that there shall be allowed as a deduction the medical expenses paid during the

year, not compensated for by insurance, to the extent that such expenses exceed 7.5% of adjusted

gross income. I.R.C. § 213(a). Most personal deductions are itemized deductions, which are

subject to reduction for high income taxpayers, under IRC § 68. Section 68 is an overall limitation

on itemized deductions, which reduces itemized deduction by the lesser of three percent of the

taxpayer's gross income over the applicable amount or 80%. The applicable amount of $100,000

is adjusted annually for inflation. See I.R.C. § 68.

166. 5eeI,R.C. § 162(a).

1 67. See generally Heen, supra note HI; Allan J. Samansky, Child Care Expenses and the

Income Tax, 50 Fla. L. Rev. 245 (1998); Brian Wolfman, Child Care, Work, and The Federal

Income Tax, 3 AM. J. TaxPOL'y 153 (1984).

168. 40 B.T.A. 1038 (1939), ajfdper curiam, 113 F.2d 1 14 (2d Cir. 1940).

169. See id at 1039.

1 70. See id. The taxpayers attempted to deduct the expense of hiring a nursemaid to care for

their infant child as an ordinary and necessary business expense under the Revenue Act of 1936,

section 23(a).

171. Mat 1040.
172. See Tax Reform Act of 1976, Pub. L. 94-455, § 504(a)(1), 90 Stat. 1563 (1976). >



1999] PROTECTING CHILD CARE WORKERS 1215

The current deductibility of child care expenses depends on who incurs the
cost. Child care is considered an ordinary and necessary cost of doing business

for an employer, who is entitled to deduct the cost of building and operating a
child care facility. However, for the private household employer, child care is

treated as a mere luxury unrelated to the production of income. The disparate
treatment afforded individual child care expenses is more troubling when the
individual is saddled with the responsibility of functioning as an employer for

employment tax purposes. Imposition of employment tax requirements should
entitle the individual employer to the same deduction for employing a child care

as a corporate employer. This is not to suggest that individuals should be

allowed to deduct the cost of maintaining a child care facility for their own
children, but that a limited deduction is justified when an individual taxpayer is
required to function as a provider of child care services for purposes of paying

employment taxes.
2. Salary Deduction for Wages Paid to Child Care Employees.

—
^The

treatment ofchild care expenses as inherently personal, or as an expense incurred

by a taxpayer in carrying on a trade or business, has received ample scholarly
consideration. And while the personal versus business dichotomy is relevant in
determining the deductibility of child care, it does not adequately address the

issues particular to domestic employers. The question that must be answered is,
whether a justification exists for treating the domestic employer/employee

relationship differently from other employer/employee relationships.

Reasonable salaries that are incurred in connection with a taxpayer's trade

or business are deductible from gross income.^^^ The expenses must be directly
related to the conduct of a trade or business and not just expenses like child care,

which enable the taxpayer to go to work.'^'* However, salaries need not be
incurred in connection with an ongoing trade or business to be deductible. IRC
§ 212 provides for the deduction of salary expenses incurred by the taxpayer for

the production or collection of income.
^^^

1 73. IRC § 162(a)(1) provides that "there shall be allowed as a deduction all the ordinary and

necessary expenses paid or incurred during the taxable year in carrying on any trade or business,

including a reasonable allowance for salaries and other compensation for personal services actually

rendered." I.R.C. § 162(a)(1) (West Supp. 1998).

174. There is no provision in the IRC that permits the deduction of child care expenses

unrelated to the production of income. A limited child care credit is provided under IRC § 21 to
enable the taxpayer to work. I.R.C. § 21.

175. IRC § 212 provides that an ordinary and necessary expense may be deducted from

income if it has been paid or incurred during the taxable year: (i) for the production or collection

of income that will be included in the taxpayer's gross income; (ii) for the management,

conservation, or maintenance of property held for the production of income; and (iii) in connection

with the determination, collection, or refund of any tax. I.R.C. § 212. The Department of Treasury

regulations refer specifically to the deduction of salaries by providing that fees for clerical help paid

or incurred by the taxpayer held by him are deductible if they are paid for the production or

collection of income, for the management, conservation, or maintenance of investments held by

him, and are ordinary and necessary. Treas. Reg. § 1.2 12- 1(h) (1998).



1216 INDIANA LAW REVIEW [Vol. 32:1 187

In Higgins v. Commissioner,^^^ the IRS disallowed a deduction for salaries
paid to clerical help and other fees associated with an office Higgins maintained
to manage his personal investments.^^^ The clerical workers retained in the
Higgins case opened his mail and forwarded financial statements to him in
France where he lived half of the year.^^^ The clerical workers did not provide
investment advice with respect to his stock trading and/or other financial

dealings.
^^^ The United States Supreme Court disallowed the deduction, finding

that the taxpayer's frequent investment activities were insufficient to overturn the
decision of the Board of Tax Appeals that Higgins was not carrying on a trade
or business.

^^°

The congressional reaction to Higgins was negative,^*^ prompting enactment
ofIRC § 212, which allows the deduction ofexpenses incurred for the production
and collection of income, or for the maintenance of income-producing property

unconnected to any trade or business carried on by the taxpayer.^^^ Section 212
and the accompanying Treasury Regulations expressly permit the deduction of
salaries paid for clerical help for the management of personal investments.^^^

There is no basis for distinguishing between salaries paid for carrying on a
trade or business, salaries paid to clerical help for the management and
conservation of income producing assets, and salaries paid to child care
providers. Each of these employment relationships is treated the same for
employment tax purposes.^^"* Denial of a deduction for salary paid to domestic
employees is supported only by the inequities caused by allowing some taxpayers
to deduct child care expenses while others, who are often in lower tax brackets,
cannot. However, permitting a taxpayer to take a salary deduction for the

management of personal investments because he can afford to pay someone to

176. Higgins v. Commissioner of Internal Revenue, 3 12 U.S. 212 (1941).

1 77. See id. at 214. Higgins also held rental real estate that was managed by the same office.

The expenses associated with the rental property were allowed as trade or business expenses. See

id. at 215. However, the fees associated with the management of the investment portfolio were

disallowed based on a finding that although the taxpayer's personal investment activities were

extensive, regular and continuous, they did not amount to a trade or business. See id.

178. See id. The offices kept records, received checks, and made deposits as instructed by

Higgins. See id.

179. See id. He sought permanent investments. Limited shifts in his investment portfolio

were made under his direction. See id.

180. Mat 218.
181. See James J. Freeland et al., Fundamentals of Federal Income Taxation 446

(10th ed., 1998).

182. I.R.C. § 212 (1994).

183. Treasury Regulation § 1.2 12- 1(g) provides that fees for investment counsel, clerical

help, office rent and similar fees incurred by the taxpayer are deductible if (1) they are paid or

incurred by the taxpayer for the production of income or for the management, conservation, or

maintenance of property; and (2) they are ordinary and necessary. Treas. Reg. § 1.2 12- 1(g) (1998).

184. The only difference is that domestic employers are not subject to federal income tax

withholding requirements.



1 999] PROTECTING CHILD CARE WORKERS 1217

open his mail provides a prime example of the inequities that are currently

present in the IRC.

The current policy of treating the salary ofwomen providing in-home child
care as a personal luxury has had a detrimental effect on the market for domestic

service.^*^ The non-deductibility of child care expenses encourages household
employers to cheat on their taxes by failing to report wages paid to household
employees. This puts child care providers in an enviable position: They can, in
fact, determine if they want to receive legal wages. When a worker's wages are
deductible, the employer will report them to the IRS, regardless ofhow much the
worker wants to be paid under the table. '^^ On the other hand, the non-
deductibility ofwages perpetuates wage depression and allows an underground,
often illegal, labor market to thrive.

A salary deduction for in-home child care providers legitimizes the
employer/employee relationship. Treating child care workers as "real"

employees lifts the veil ofsecrecy that shrouds domestic service. Implementation

of a federal tax policy that recognizes domestic work as employment, and
domestic workers as employees, is the first step toward nannies gaining parity

with other workers with respect to pay, benefits, and working conditions.

Conclusion

The devalued status of domestic work is reflected in laws that fail to provide
domestic workers with benefits afforded to other workers. Disregard for the

interests of domestic workers is reflected in a federal tax policy that fails to

enforce federal employment tax requirements and treats salaries paid to domestic

workers differently from salaries paid to workers who provide labor outside of
private homes. Absent the grant of true employee status to domestic workers,

they will continue to be denied the employment benefits to which every laborer
is entitled.

1 85. See Frum, supra 89 (theorizing that the market for domestic servants is choked by two

pressures, one economic, the non-deductibility of child care expenses, the other cultural).

1 86. See id. Because a secretary's wages are deductible, the employer will report them even

if the secretary would be preferred to be paid under the table. But when a nanny asks to be paid

under the table, the employer loses nothing by winking at the illegality. See id.