You couldn’t run your small business without your nanny. Heck, without her looking after the kids, you wouldn’t even be able to go to work. So, it makes sense to put her on the company’s payroll, right?

Wrong. Your nanny is employed by your household, not your business.

U.S. law and the IRS are very clear on this point — and you run a big risk if you choose to bend the rules to make your life “easier.” In fact, if the government should ever find out, you’re likely to face and audit and potentially devastating penalties.

Here’s how to do the right thing:

• Embrace being a household employer and apply for an Employer Identification Number from the IRS.
• Ask your nanny to complete the necessary employment forms. These include an I-9 and a W-4. See IRS Publication 926 (2012): Household Employer’s Tax Guide for complete details.
• Withhold (and remit to the IRS) your share of the employee’s Social Security and Medicare taxes. Together these taxes should amount to 7.65 percent of the employee’s wages, and they are the only withholdings legally required of a household employer.
• Withhold and remit any applicable state and federal income taxes. Although this isn’t legally required, it will help your employee avoid large lump-sum bills at tax time.

Once the initial payroll and withholding process is set in place for your nanny, you’ll find that paying her separately is relatively simple. Besides, when you consider the potential alternative — audits, fines, even jail time — it’s well worth any extra effort.