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Nanny taxes and payroll: Step-by-step instructions for setting it up

Knowing how to pay nanny taxes is essential when you hire someone to work in your home

Nanny taxes and payroll: Step-by-step instructions for setting it up

Congrats! You’ve found a nanny you’d like to hire. Now what? Know that as soon as your nanny accepts your job offer, your responsibilities as an employer begin. That means putting the terms of your working relationship into a contract, deciding on benefits and setting up payroll. It also means complying to state and federal regulations, including what many people call “nanny taxes.”

Nanny taxes refer to the federal and state payroll and tax responsibilities families have to manage when they hire a nanny to work in their home.

“We actually have nannies approaching us to work for us because we pay legally,” says Paul Cuthbert, of Newport, Michigan, who has hired several nannies. “It costs a little bit more than not paying legally, but it is so worth it.”

While complying to these state and federal laws means you won’t be at risk of being slapped tax evasion fines, there are benefits for the caregivers, too. Nannies become eligible for state unemployment benefits, and a traceable payment history enables them do things like apply for credit cards, rent an apartment or lease a car.

Follow this simple compliance checklist, and you can meet the requirements laid out by the IRS and your state.

1. Know that your nanny should be classified as a household employee.

The IRS has ruled that, with very few exceptions, nannies are employees of the families for whom they work — not independent contractors. This is regardless of the amount of hours worked, wages paid or what’s written in an employment contract. This means your nanny should be given a W-2 form, rather than a 1099 form, to file their taxes. Worker misclassification is considered a form of tax evasion and is a risk you should not be willing to take.

2. Obtain federal and state employer tax IDs.

In order to file returns with the IRS and the state, you’ll need to obtain a Federal Employer Identification Number (FEIN) as well as state tax ID(s) for unemployment insurance and, if applicable, state income taxes. These tax IDs identify you as a household employer and you should apply for them as soon as your nanny accepts your job offer.

3. File a New Hire Report with the state.

All employers are required to file a New Hire Report with their state immediately after each new hire. Click here to find the agency that oversees this process in your state.

4. Withhold federal and possibly state income taxes from your nanny’s pay each pay period.

“Income taxes don’t technically have to be withheld from a household employee, but families should do it anyway so their caregiver doesn’t have to budget for the taxes on their own,” says Tom Breedlove, senior director of HomePay. “If the family doesn’t withhold and the caregiver waits until tax season to address this, they can be subject to underpayment penalties.”

You’ll know how much in income taxes to withhold from your nanny based on how they fill out their W-4 and state withholding form (assuming you live in a state that has income taxes).

5. Withhold Social Security and Medicare taxes from your nanny’s pay each pay period.

These taxes are collectively known as FICA and must be withheld from your nanny’s pay. Social Security taxes will be 6.2 percent of your nanny’s gross (before taxes) wages and Medicare taxes will be 1.45 percent of their gross wages. Use this nanny paycheck calculator to see how much you should be withholding.

6. Pay state taxes and file state household employment tax returns on a regular basis.

As a household employer, you are required to file state unemployment tax returns, typically on a quarterly basis, and remit (pay) unemployment insurance taxes. If you live in a state with income taxes, you’ll also need to file state income tax returns and send in the income taxes you’ve withheld from your nanny.

Note: Some states have different filing frequencies and could require monthly or annual deposits. Check the requirements in your state.

7. Make estimated tax payments to the IRS four times a year.

To manage your federal household employment taxes, the IRS recommends you make estimated tax payments throughout the year to avoid underpayment penalties. You’ll send in the FICA taxes and federal income taxes withheld from your nanny along with the FICA taxes and federal unemployment insurance taxes you owe as a household employer during the following time periods:

  • January – March (paid in April)

  • April and May (paid in June)

  • June – August (paid in September)

  • September – December (paid in January of the next year)

8. Prepare year-end tax forms.  

Once the calendar year ends, you’ll need to provide your nanny with their W-2 and file Form W-2 Copy A & Form W-3 with the Social Security Administration by the end of January. These forms summarize the wages you paid to your nanny, as well as the taxes that were withheld from them throughout the year. Since you’ve been keeping track of your nanny’s pay all year long, these forms should be relatively simple to complete. Additionally, you’ll file a Schedule H with your personal income tax return by the April 15 deadline.

Use this checklist during the year so you can avoid expensive, time-consuming mistakes. If you don’t want to manage this paperwork yourself, you can hire an accountant or use a nanny payroll service. While it may seem like a lot of work, when you handle all of your household employment responsibilities correctly, there are benefits: You become eligible for tax breaks that can help offset some of tax payments you’ve made during the year. In addition, your nanny will be entitled to the benefits that come with being paid on the books, such as Social Security, Medicare and unemployment insurance — benefits that all workers need and deserve.