One of the most common concerns families have when they hire a nanny is how much in taxes they’ll be responsible for paying. The good news is that families can qualify for at least one – if not two – tax breaks that can make paying their nanny on the books less expensive than paying under the table.
1. 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 $10,500 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 $4,800 in 2021. For enrollment details, check with your HR or Accounting Department.
2. 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. A majority of families will receive a 20% tax credit on up to $8,000 of care-related expenses if you have one child, or $16,000 of care-related expenses if you have two or more children. This means your tax credit is up to $1,600 for one child and $3,200 for two or more children.
If you have one child, your best option is usually the FSA. Setting aside the full $10,500 will save between $3,700 and $4,800 this 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 $10,500 and if you have leftover child care expenses, you can apply another $5,500 toward the Child or Dependent Care Tax Credit. This combination saves you an additional $1,100 per year, which brings your total savings to between $4,800 and $5,900 for 2021.
How do I qualify for a nanny tax deduction?
“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. The Child or Dependent Care Tax Credit does have a $440,000 income limit, so you should factor that 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 information contained in this article is general in nature, may not be applicable to your specific circumstances, and is not intended to be a substitute for or relied upon as personalized tax or legal advice.