Tax breaks and credits for families hiring a nanny
Learn how much money you can save by paying your nanny legally
One of the most common concerns families have when they hire a nanny is how much in taxes they’ll be responsible for paying. Sure, there are several important benefits a nanny receives by being paid on the books, but families also want to make sure their care budget is set appropriately. The good news is that most families with child care needs will qualify for at least one - if not two - tax breaks that can significantly lower their household employment tax liability.
What tax breaks are available when I pay my nanny legally?
Dependent Care Account. A type of Flexible Spending Account (FSA), this tax break is available through the benefits package offered by most companies. You can use an FSA to pay for up to $5,000 of child care-related expenses - such as your nanny’s pay - using pre-tax dollars. Depending on your marginal tax rate, using an FSA can save as much as $2,300 per year. For enrollment details, check with your HR or Accounting Department.
Child or Dependent Care Tax Credit. To take this tax break, use IRS Form 2441 to itemize care-related expenses on your federal income tax return. You receive a 20% tax credit on up to $3,000 of care-related expenses if you have one child, or $6,000 of care-related expenses if you have two or more children. This means your tax credit is up to $600 for one child and $1,200 for two or more children.
How can I maximize my savings using child care tax breaks?
If you have one child, your best option is the FSA. Setting aside the full $5,000 will save between $2,000 and $2,300 per year, depending on your marginal tax rate and which state you live in. If you don't have access to an FSA (or cannot enroll at the moment), use the Child or Dependent Care Tax Credit.
If you have two or more children, you may be able to take advantage of both tax breaks. Use your FSA for the full $5,000 and if you have leftover child care expenses, you can apply another $1,000 toward the Child or Dependent Care Tax Credit. This combination saves you an additional $200 per year, which brings your total savings to between $2,200 and $2,500 per year.
How do I qualify for tax breaks when I hire a nanny?
“The most important thing to remember is that you can’t qualify for a tax break on your child care expenses if you aren’t paying your nanny legally,” says Tom Breedlove, Sr. Director of Care.com HomePay.
Assuming this is not an issue, these tax breaks are available to you if your children are under the age of 13 and you have care-related expenses because both you and your spouse work, are looking for work or are full-time students. Child care expenses can be your nanny’s wages, the wages paid to a backup child care provider, the taxes your incur on your nanny’s wages and even the money paid to a placement agency. Neither the FSA nor the Child or Dependent Care Tax Credit have an income limit, so you don’t have to worry about that factoring into your eligibility.
When you sign up for Care.com HomePay, the paystubs we generate for you can serve as proof of child care expenses. This will allow you to use your FSA and/or keep track of how much to apply to the child care tax credit.
* 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 adviser 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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