Updated: Nov 11, 2020
This year feels like the longest I've ever experienced. With 3 kids home from school all spring and summer (and actually still home now!) it's disorienting that we're actually nearing the end of 2020.
As a CPA, this time of year puts me into full preparation mode; there are only a few short months to make sure my family's financial ducks are in a row and that we've incorporated all the tax-saving strategies we can use to lower our tax bill come April.
When it comes to paying nanny taxes, there are some easy, legitimate strategies you can start using right now to lower your taxes and maybe even make your nanny happier!
Before we get into my top 5 nanny tax tips, let's answer a couple of common questions. If you're new to nanny taxes, check out our comprehensive post for an introduction.
Are nanny taxes deductible?
The simple answer is no. While there are some great tax credits you can claim - which we'll get into below - you cannot directly write off your nanny's wages on your taxes.
Can I hire my nanny through my business and deduct the wages?
I get the logic here - it's tempting to think that a nanny's wages are essential to a business if you need a nanny to watch your kids so you can work on said business. However, the IRS is quite clear that nannies work for your household, not your business and you cannot deduct their wages as a business expense.
The IRS does allow you to include your nanny's payroll in your business payroll tax return submissions as a convenience (and only if you have a sole proprietorship or for-profit farm), but that is for reporting purposes only and you cannot take a business deduction for nanny taxes.
Without further ado, here are 5 ways you can reduce your nanny taxes - if you're paying your nanny over the table, of course.
1. Use Your Employer-Provided Dependent Care Flexible Spending Account (FSA)
A dependent care FSA is probably the easiest, most surefire way to save money on nanny taxes. This gives you the opportunity to pay for up to $5,000 in eligible childcare expenses with pre-tax dollars.
If your employer provides this benefit, sign up to create an account during the next open enrollment period. You will choose an amount of your pre-tax income to get taken from your paycheck and contributed to your dependent care account. 2020 limits are $5,000 for individuals or married couples filing jointly, and $2,500 for married couples filing separately.
Throughout the year, when you incur eligible childcare expenses, submit a request to be reimbursed by your FSA and get your pre-tax money back in your pocket. If you contribute the full $5,000 for the year, average savings end up being around $1,500, which can go a long way toward covering nanny taxes.
Watch out for these couple things that trip people up:
If you and your spouse are both offered dependent care FSAs through your employers, you can both sign up for accounts, but your contribution limit as a family is $5,000. You can split that up however you like, but you cannot elect more than $5,000 for the year.
Make sure you only get reimbursed for eligible childcare expenses. This is not hard to do, since eligible expenses include nanny wages, au pair fees, preschool tuition, and more. Paying a babysitter while you go out for a date night is, unfortunately, not eligible.
The amount you contribute to your FSA for the year is a use it or lose it deal. In my experience, most working parents with a nanny hit the $5,000 dependent care threshold easily. But if you have a very part-time nanny or your childcare situation is changing soon, make sure you only contribute what you think you will use.
2. Claim the Child & Dependent Care Tax Credit
If you don't have the option to use a dependent care FSA, you may be able to claim the full Child & Dependent Care Tax Credit. To claim the credit, you must have earned income and have paid someone to care for an eligible dependent.
The maximum amount of care expenses you're allowed to claim is $3,000 for one dependent, or $6,000 for two or more dependents. If your employer gives you money to pay child care expenses, or if you contribute pre-tax dollars to a dependent care FSA, you must subtract this money received from your allowable expenses.
Compare your claimed childcare expenses with your earned income and, if you're married, your spouse's earned income. Take the smallest of all these amounts. These are your "allowable expenses."
Your credit will be a percentage of your allowable expenses, which ranges from 20% to 35%. The higher your income, the smaller your percentage, and therefore the smaller your credit.
Most DIY tax preparation software (ie. TurboTax) will help you figure out the credit based on your income and your childcare expenses.
3. Provide Your Nanny With Health Insurance
While this strategy may not seem like a money-saver at first, consider that there are options for household employers to provide tax-free contributions to their nannies' health insurance premiums or out-of-pocket costs.
While you will pay taxes on every dollar paid to your nanny as wages or bonuses, if you could lower the hourly rate and instead pay for some portion of your nanny's health insurance tax-free, you'll save on taxes and provide a crucial benefit for your nanny at the same time!
Your options for providing health insurance to your nanny are:
Contribute to your nanny's Individual Coverage Health Reimbursement Arrangement (ICHRA): Families can reimburse their nanny for qualified health expenses and/or health insurance premiums through an ICHRA. There is no cap for how much families can contribute to an ICHRA, but if you have other employees enrolled in their own health plans, you must offer the reimbursement arrangement to all of your employees. Families can also choose to offer different reimbursement amounts to each employee they have and employees have the option to opt-out of the ICHRA if they choose. This cool company provides simple ICHRA administration at affordable prices. They even have an affordability calculator to help you decide if this makes sense for your situation.
You can also Offer to set up a Qualified Small Employer Health Reimbursement Arrangement (QSEHRA): You can offer a QSEHRA to contribute up to $5,150 annually per employee to their health insurance premiums and qualified health expenses tax-free. If you have multiple household employees, they must all have the ability to accept the arrangement, but they’re not obligated to do so.
You must decide before the calendar year begins how much you are willing to contribute and then reimburse your caregiver for their qualified expenses. Your caregiver(s) must provide receipts to receive reimbursement and the amount you decide to contribute will be reported on your caregiver’s W-2. Check out this company's QSEHRA's administration if you're interested in this option.
4. Sweeten Your Nanny's Offer With Non-Cash, Non-Taxable Perks
Perks can go a long way toward keeping your nanny happy and may mean you can save a dollar or two an hour. This adds up over time and translates into tax savings on those lower wages as well. Some inexpensive ways to sweeten the job offer?
Give your nanny access to your car for driving kids around instead of making him or her use their own vehicle. You can feel comfortable that your kids are in a safe car and your nanny's vehicle can avoid the typical wear-and-tear.
Provide meals and snacks while your nanny is working.
Keep the fridge stocked with sparkling water, soda or other work-appropriate beverages.
Provide memberships to the zoo, aquarium, museums, or spring for the occasional matinee movie. This can provide educational experiences for your kids while giving your nanny the chance to enjoy these destinations, too!
5. Non-Taxable Transportation Benefits
If your nanny commutes to your house, offer to pay for the bus or train pass, or if you live in an area with expensive parking, you can offer to subsidize a parking pass. Families can provide up to $270 each month in tax-exempt transportation benefits, so discuss with your nanny if commuting is a significant expense. You could both end up saving on taxes!