Taxing Domestic Help, Roth IRA Conversions, More

Q. We employ a woman to clean our house twice a month at $70 per visit. Are we responsible for paying any taxes?
—John Quinn, Brooklyn, N.Y.

Count yourself lucky: Your payments are just small enough that you don’t have to worry about employment tax. Folks who pay household employees wages of $1,700 or more in 2009 (you’re $20 short!) must pay Social Security and Medicare taxes, which carry a 7.65 percent employer contribution and a 7.65 percent withholding for the employee contribution. Wages over $1,000 per quarter are also subject to a federal unemployment tax of 0.8 percent on the first $7,000. (Separately, you may also have to pay state taxes.)

If you give your cleaner a raise, will you owe? Broadly speaking, if you’re the boss, you pay the tax. (Whether she’s full-time or part-time is irrelevant.) So if the cleaner doesn’t work for an agency or other employer, and if you’re providing the cleaning materials and determining what work is done and how, then you likely have a household employee and taxes are due, says CCH principal tax analyst Mark Luscombe. But a worker who’s self-employed (and therefore pays her own taxes) typically offers her services as an independent business, provides her own materials and controls how and when the work is done.

Q. My wife and I have most of our retirement savings in traditional IRAs. About 15 percent is from nondeductible contributions. What are the pros and cons of converting to a Roth IRA in 2010?
—Brenk Johnson, Dallas

Roth IRAs offer a couple of eye-catching perks over traditional IRAs: tax-free withdrawals during retirement and no required minimum distributions. That makes them excellent savings vehicles for retirement income and estate planning.

Although Roth conversions are currently limited to those with income under $100,000, that restriction goes away in 2010. When converting to a Roth, ordinary income taxes are due for contributions on which you’ve taken tax deductions and on earnings. (You can’t convert just your nondeductible contributions; with partial Roth conversions, each dollar is treated as a blend of what’s taxable and nontaxable based on your total IRA balances.) Still, converters in 2010 can take advantage of a potential break, spreading out the taxable conversion income into 2011 and 2012.
Conversions are a smart move for those who expect to be in a higher tax bracket during retirement. Given our current federal deficit, that’s a scenario that’s not too hard for many to anticipate.

Q. A friend of mine has several credit lines listed as “charged off” on his credit report. What does this mean?
—Amanda Bennett, Wichita, Kan.

To future lenders, it’s a flashing danger sign. Charged off is a bookkeeping term used by creditors when a loan moves from the profit to the loss side of the books. This usually happens when a debt goes unpaid for six months. “It’s among the most negative items you can have on your credit report,” says Barry Paperno, consumer operations manager for credit scorer FICO. Several recent charge-offs could drop your score below 600—or even under 500. (Scores range from 300 to 850.) A charge-off lurks on a credit report for seven years.

If the debt is outstanding, the lender could still sue for payment or sell the debt to a collection agency (which may also sue). This can lead to more negative credit-report entries for the same debt. But happily, time heals all credit-report wounds. A secured credit card and on-time payments will speed your pal’s recovery.