Nanny Tax Forms and Procedures: What Are They All About?
Lots of families are unsure of their responsibilities and exactly what the IRS wants them to do
Many parents understandably get squeamish over the topic of nanny taxes. 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 Tom Breedlove, Sr. Director of Care.com HomePay.
If you pay a caregiver $2,100 or more per year, you have to pay taxes. 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 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. All it takes is for your former nanny to file for unemployment benefits for the state and the IRS to realize you've never paid household employment taxes. Or if the working relationship between you and your nanny sours and they file a wage dispute, your lack of tax payments could easily be brought to light.
- 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. 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 in Nanny Taxes?
A good estimate is 10 percent of your nanny's gross wages, but this can vary by state. Social Security taxes are 6.2% and Medicare taxes are another 1.45%. The rest is made up of unemployment insurance taxes and any additional taxes your state may assess. Check the details in your state for more information.
If you'd like to run a specific budgeting scenario, check out our nanny tax calculator for a quick answer.
Are there Tax Breaks to Help with the Extra Tax Payments?
Yes. Household employers can't tax deduct employees' wages the way businesses can, but you can take advantage of a couple of tax breaks to offset the tax liability you take on by hiring a nanny:
- Pay your nanny with pre-tax dollars. Ask your employer if they offer a Dependent Care Account (a type of FSA). This lets you set up to $5,000 of your annual income aside before taxes and then use that money to pay your child care 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. Your tax savings will depend on the tax bracket you're in, but most families save about $2,000 per year.
- You may qualify for the federal dependent and child care tax credit. This lets you claim 20 percent of the first $3,000 you spend on child care if you have 1 child, or $6,000 if you have 2 or more children. This results in up to either $600 or $1,200 in savings. If you have one child, you'll have to choose between this tax credit and a Dependent Care Account. If you have 2 or more children, you can use both! Your first $5,000 in child care expense will go toward the FSA and an additional $1,000 can be put toward the child care tax credit.
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 HomePay. 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 an award-winning consulting team available to answer any questions that may come up during the time your nanny works in your home. 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.