Nanny Tax Forms and Procedures: What Are They All About?
Lots of families pay under the table. But is the risk worth the savings? Here's what you need to know.
There are few conversation topics that make parents more squeamish than nanny taxes. Case in point: We couldn't find any moms willing to go on the record about how they handle their nannies' income. The truth is, whether it's because taxes seem too confusing or expensive, there are a lot of families paying nannies "under the table," which is illegal.
But are the weekly savings and lack of paperwork worth the risk? "The IRS is very clear; if you have a household employee, you must withhold and pay employment taxes," says Stephanie Breedlove, head of Care.com HomePay, managed by Breedlove.
Not only is it illegal if you don't (more on that in a minute), but it may also do your nanny a huge disservice -- setting her up for a future without retirement benefits and leaving her to apply for a mortgage or a car loan without proof of income.
Your nanny is probably the only person who spends more time with your child than you do -- are you comfortable knowing that you're both skirting the law? "I've had clients tell me they pay taxes simply because in their profession, customers expect them to do things the right way. They're not considered trustworthy if they do the opposite in their personal lives" says Breedlove.
Here's what you need to know about paying taxes for your nanny:
What Are the Benefits of Paying Taxes?
Taxes aren't all bad. Here are a few of the benefits of paying your nanny legally.
- Financial security for your nanny -- now and in the future. Paying income tax will ensure that your nanny can build a work history, collect unemployment if you have to let her go and qualify for essential government benefits like worker's compensation, Medicare and Social Security payments later in life.
- Peace of mind for you. You may think that if you're not running for office, you'll never get caught not paying taxes. But it happens more often than you'd think. "The most common way that people get in trouble for not paying these taxes is when your nanny tries to file for Medicare or Social Security at some point down the road," says Amy Torres, an attorney and nanny success coach. Adds Breedlove: "Or the nanny may have to file for unemployment benefits, at which point she'll have to list all the families she's worked for over the past several years."
- You don't want to get caught. If you get audited, go through a messy divorce or your nanny reports her income to the IRS (see above), your under-the-table payments can come back to haunt you -- in an expensive way. "You'll have to pay all the taxes you should have remitted in the past, including the Social Security and Medicare taxes that should have been withheld from the employee's pay," warns Breedlove. You may also be subject to large fines -- the amount of which can vary substantially based on IRS analysis and the severity of the case. "These fines are going up as the government is paying closer attention to household employees," notes Torres. And if you're a lawyer, doctor, or in another profession that is licensed by the state, you may face professional penalties or even lose your license.
Find out if you're on the list of the Top 11 Professions Most at Risk if Not Paying Nanny Taxes »
How Much Will I Have to Pay?
Check out our nanny tax calculator for a quick answer.
You'll likely need to withhold around 13 to 20 percent of your nanny's gross wages to cover federal and state taxes (between 1 and 5 percent), as well as Medicare and Social Security (employers are responsible for 7.65 percent, while employees currently pay 5.65 percent -- this might go back to 7.65 percent in 2012), depending on your nanny's income and your own income and tax bracket.
Here's an example: Say you pay your nanny $600 per week ($15 per hour, 40 hours per week), you'll need to withhold the following from her take-home pay:
- Federal Income Tax: $75.77
- Social Security: $25.20
- Medicare: $8.70
- State Income Tax (3.7%): $22.30 (note: we used New York State. Here's where you can find your state income tax rate.)
Total withholdings: $131.97
You'll also need to make the following contributions:
- Federal Unemployment: $4.80
- Social Security: $37.20
- Medicare: $8.70
- State Unemployment: $24.60 (note: we used New York State. Find yours by contacting your state unemployment tax agency)
Total Additional Payments: $75.30
This means your weekly bill comes to $675.30 per week, and your nanny will take home $468.30. Over the course of the year, you can expect to shell out $33,991.30 -- $2,791.30 more than if you paid a flat $600 per week under the table.
Consult the IRS' Household Employers Tax Guide for more details on each of these withholdings.
Doesn't that Mean I Pay More and My Nanny Gets Less?
Week-to-week, yes. Household employers can't tax deduct employees' wages the way businesses can, so you end up paying the majority of your nanny's salary with your own after-tax income. And she'll take a hit in her weekly paycheck when you start withholding the government's piece of the pie. So you may need to increase your nanny's salary so that her take-home pay doesn't take as much of a hit (again, use this Nanny Tax Calculator to run your own numbers).
The Good News:
But there are more benefits!
- You can pay with some pre-tax dollars. Ask your employer if they offer a Dependent Care Account (DCA). This lets you set up to $5,000 of your annual income aside before taxes, and then use that money to pay your childcare bill. Reducing your overall taxable income will reduce your overall tax burden, which may help balance out the extra you're paying in nanny taxes, but can get maxed-out if your child is also in a preschool program.
- You may qualify for the federal dependent and child care tax credit. This lets you claim around 20 percent of the first $3,000 you spend on child care per child. This tax credit, combined with your DCA, can save you about $1850 per year -- meaning you're only coughing up an extra $941 at the end of the day, to pay your nanny's taxes using the numbers above. (Note: If you have one child, you'll have to choose between this tax credit and a DCA.)
- Your nanny earns more in the long-term. Think of that extra $75.30 per week as a deferred raise for your nanny -- because she'll be able to collect on it when she files for Medicare, Social Security or unemployment. "When nannies understand the benefits and financial protections that come from our payroll tax system, they're much more comfortable with the idea of being paid above board," notes Breedlove. This should provide some assurance to your nanny if she is nervous about how she'll manage with less take-home pay.
How Do I Set Up My Tax Payments?
The most efficient way to pay taxes on your household employees is to sign up with a payroll service like Home Pay. For a quarterly fee, they'll direct deposit your nanny's paychecks to her bank account, withhold all appropriate taxes and file them electronically. They also have easy and free nanny tax calculators you can play with to determine how much your nanny will take home at the end of the day.
The most important thing to keep in mind is that you can handle this process. It might seem like a lot, but once you get the hang out it, you'll be fine -- and legal!
Your Next Steps:
*The tax information contained in this article should not be used for any actual nanny relationship without the advice and guidance of a professional tax advisor who is familiar with all the relevant facts. The information contained herein is general in nature and is not intended as legal, tax or investment advice. Furthermore, the information contained herein may not be applicable to or suitable for your specific circumstances and may require consideration of other matters.
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