Tax Breaks When Hiring Domestics

Q. I want to hire a domestic and I realize I will be liable for certain employer taxes, such as Social Security, Medicare, state disability insurance, and unemployment insurance. However, am I eligible to claim any tax credits, such as the one available if my worker lives in an enterprise zone? And, how do I handle payment of Social Security and Medicare taxes? -- W.H.W .

A. The so-called enterprise zone tax credit offered through the state Department of Trade and Commerce is available only to businesses located in the designated zones. It doesn’t matter where the employee lives. If your home was located in an enterprise zone, and your business were home-based, it is conceivable that you would qualify for the tax credit if your worker were employed by your business. However, the paperwork involved could be staggering for the amount of tax credits you would be entitled to receive.

Businesses that hire employees enrolled in the Job Training Partnership Act or the Avenues for Independence “workfare” program are also entitled to tax credits. But these credits are not available to individual employers.

The federal government requires that employers pay both the employer and employee share of Social Security and Medicare taxes, a total of 15.3% of wages for domestic workers. For the 1995 tax year, you should report and pay these taxes when you file your annual tax return next year. A new form, Schedule H, has been created for the 1995 tax year for employers of domestic workers. Beginning in 1998, the government will begin requiring payment of these taxes either quarterly by the employer or through employee withholding.

Tapping Your IRA Outside California

Q. In a recent column you said state taxes and any applicable penalties on individual retirement account withdrawals should be paid to the state where the taxpayer is residing at the time the withdrawals are made. What if you move to a state with no state income tax? Are you able to withdraw from your IRA on a tax-free basis? -- J.R.K .

A. In general, states do not tax the interest accumulated in savings accounts built up or maintained within their boundaries by non-residents.

However, this general rule does not apply to all IRAs. Furthermore, some states, especially California, are increasingly trying to go after tax-deferred accounts that have been accumulated by taxpayers while residing here, but withdrawn while residing in a state with no state income tax, such as Nevada and Florida.

So, be forewarned: California may still try to tap your IRA, especially if you roll over 401(k) plan proceeds or another tax-deferred employee savings into an individual retirement account.

That said, let’s proceed with some of the practical and messy nuances.

If you did not take a state income tax deduction at the time you made your IRA contribution, you are liable for applicable state income taxes at the time you make your IRA withdrawal. If you are residing in a state with no income tax, you will pay no state taxes on the amount of principal withdrawn.

However, if that principal has generated untaxed interest, the state where you formerly resided may try to tax it on the theory that the interest was unearned--and not taxed--while you resided there. This is the position California tax authorities are staking out.

Furthermore, if you did take a state tax deduction when you made your IRA contribution, that state may expect you to pay state taxes on your withdrawals regardless of where you are living at the time of the disbursement. This is the stance taken by California taxing authorities. (You are eligible for a tax credit from your current state of residence if that state imposes a tax.)

Practically speaking, however, California officials acknowledge that it is difficult and ultimately unprofitable for the state to enforce its position, especially when relatively small sums are involved.

Still, state officials are becoming more aggressive about the considerably larger lump sum distributions from tax-deferred employee retirement savings plans, such as 401(k) accounts, when they are rolled over into IRAs. The state does not want to miss its fair share when these accounts are tapped, regardless of where the taxpayer has moved.

Some taxpayers are trying to sidestep state tax collectors by rolling over their lump-sum distributions into IRAs at banks in the state where they intend to move.

While crafty, these maneuvers may not outfox sophisticated computer systems programmed to track employees participating in tax-deferred saving plans at companies within California. If the tax collector finds you in a neighboring state, you could not only be liable for the back taxes but for penalties and interest as well.

This maneuvering has been complicated by the retiree-haven states of Nevada and Florida that in recent years have passed so-called “shield laws” refusing to acknowledge liens and judgments against residents of those states who won’t pay California income taxes. California is waiting for the right case to arise before challenging any of these laws, tax authorities say.

The upshot of this is still unclear. Federal legislation may be passed to create uniform, national regulations. Stay tuned . . . .

Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Please do not telephone. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053