How To Save Money On Nanny Taxes | CPA-Approved Tax Strategies
While filing taxes for the year is in the rearview mirror, here at Nanny Files we think summer is the best time to evaluate tax-saving ideas for next year.
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 next 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 ways to save on nanny taxes, 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 frustrating answer is "not really." 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.
But keep reading, because there are some lesser known but very legal ways to reduce your tax bill.
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. 2021 limits were significantly raised and are now at $10,500 for individuals or married couples filing jointly, and $5,250 for married couples filing separately.
This is huge! Read on to find out how a dependent care FSA can help you save on taxes.
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 $10,500 for the year, average savings end up being around $3,150, 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 $10,500. You can split that up however you like, but you cannot elect more than $10,500 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 $10,500 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 amounts you're allowed to claim have also increased in 2021 due to the American Rescue Plan Act - read on for the details.
The maximum amount of care expenses you're allowed to claim is $8,000 for one dependent, or $16,000 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 50%. 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.