Updated: Nov 11, 2020
Ok, so you’ve heard that there’s this thing called the Nanny Tax and it sounds like another headache you might have to deal with. You’ve been searching around for a second opinion on whether or not you actually have to pay the thing. I get it; I’ve been there. As a budget-conscious CPA and mother of 3 who intensely dislikes overpaying on taxes (or anything), I've made it my life's work to help working parents save time and money - especially on their nanny tax filings. So let's break nanny taxes down into what matters:
Do you really need to pay nanny taxes?
What exactly are nanny taxes?
What happens if you don’t pay nanny taxes?
How and when do you pay nanny taxes?
Are there ways to reduce your nanny tax bill?
Do I Have To Pay Nanny Taxes?
Let’s start with a little assessment of your particular situation.
Is your nanny your employee?
You only have to pay household employment taxes if your nanny or other household worker is your employee. So let’s figure out if that’s the case:
Will you pay a nanny, babysitter, learning pod teacher, housekeeper, landscaper, or other household service provider this year? If yes, continue. If no, you do not have an employee
Does the nanny (or other household worker) provide services in your home? If yes, continue. If no, you do not have an employee
If you drop your children off at a nanny’s home, the nanny is generally not considered your employee
Do you control when and where the work is done and provide supplies? If yes, continue. If no, you do not have an employee
If a nanny is working in your home and the schedule is determined by you (even if it changes week to week or you offer flexibility in start/end times), this is an employer/employee relationship
Exception: If you hire a nanny through an agency and you pay the AGENCY who in turn pays the nanny, the nanny is not your employee.
Exception: A housekeeper or landscaper arrives to work at your home at a time that works for them, they have other clients, and they use their own supplies (cleaning supplies, vacuum, lawn mower, etc.) - this does not constitute an employer/employee relationship
If you answered yes to all 3 questions above, congratulations! You are the freshly minted employer of a household worker. When you step back and think about it, it’s pretty cool that you’re able to provide a real job for a real person. And with that reality comes responsibility - it’s your job to make sure your nanny gets credit for their time spent working and for that you can get a few sweet tax breaks. Read on to learn if you will owe taxes for your employee and what tax-saving strategies might work for you.
Do you need to pay nanny taxes?
If you pay your household employee $2,200 or more during the calendar year or $1,000 or more in one calendar quarter, you will owe at least some sort of tax. The next section discusses what those taxes are and when you owe them.
But first, even if you’ve decided you have an employee, there are some special situations where you don’t have to pay employment taxes on their wages even if you hit those thresholds.
You do not need to pay nanny taxes on wages paid to:
Your child who is under the age of 21
An employee under the age of 18 at any time during the year, UNLESS the household services are the employee’s primary occupation. If the employee is a student, the household services are not considered the primary occupation.
Your parent, with an exception
You DO need to pay nanny taxes on wages paid to your parent if both conditions 1) and 2) below are met. You need BOTH of these conditions to be true; it’s not either/or:
Your parent cares for your child who is either under the age of 18 OR has a physical or mental condition that requires the personal care of an adult for at least 4 continuous weeks during the calendar year. (Tip: this condition is met by most families with children)
Your marital status is one of the following:
You’re divorced and haven’t remarried
You’re a widow or widower
You’re living with a spouse whose physical or mental condition prevents him or her from caring for your child for at least 4 continuous weeks during the calendar year
For more details on the assessment above, check out the IRS’s Household Employer’s Tax Guide.
What Are Nanny Taxes and Are They All Required?
Alright, so you’ve determined that you have an employee, you have or will pay that employee at least $1,000 this year, and your situation does not include any of the exceptions above.
Let’s talk about which taxes you might need to pay.
Social Security & Medicare Taxes (FICA)
Required? If you pay your nanny $2,200 in one calendar year, you are required to pay FICA taxes.
What is it? FICA taxes are Social Security and Medicare contributions, and they are split into an employee portion (which your nanny is responsible for) and an employer portion (which you are responsible for). As an employer, you have to withhold your nanny’s portion of the FICA taxes, hold onto them, and send that amount along with your portion to the IRS.
What’s the tax rate? 6.2% for Social Security, 1.45% for Medicare for a total of 7.65% for each employee/employer portion (or 15.3% combined)
Federal Unemployment Tax (FUTA)
Required? If you pay a combination of all household employees $1,000 or more in one calendar quarter, you will need to pay federal unemployment tax.
What is it? FUTA is required by the Federal Unemployment Tax Act, which helps states pay unemployment benefits to workers who lose their jobs.
What’s the tax rate? 0.6% effectively, as long as you pay your state unemployment taxes on time. The effective rate can go as high as 6.0% if you fail to pay your state unemployment taxes.
State Unemployment Taxes
Required? In most states, unemployment taxes are required if you pay your nanny $1,000 or more in one calendar quarter
What is it? Also known as unemployment insurance, it’s a tax that employers pay into so employees can access unemployment compensation if they get laid off.
What’s the tax rate? This varies by state, but on average it tends to be between 1-2%.
Workers Compensation Insurance
Required? This varies by state. You’ll need to check with your own state employment agency to see if household employers need to carry workers compensation insurance.
What is it? Workers compensation insurance assists with medical expenses and lost wages if an employee has a work-related injury or illness. It also provides protection to the employer since workers who accept benefits generally forfeit their right to sue the employer regardless of fault. Quick tip: your homeowners insurance may offer a rider for household employees - a simple, affordable first step is checking with your policy to see if that's an option.
What’s the tax rate? This varies by state, but on average it tends to hover around 2.0%
Income Taxes (Federal and State)
Required? Nannies and other household employees are required to pay income taxes on any wages they earn while working for you and those wages need to be reported on a W-2. However, the IRS states that you do not need to withhold federal income taxes from your nanny’s paycheck unless the nanny requests withholding and you agree. States typically follow the federal rules on income taxes.
What is it? If you and your nanny agree to withhold income taxes to help your nanny avoid a large tax bill in April, you can withhold a percentage of their paycheck and send it to the IRS on their behalf. The IRS has instructions on how to calculate withholdings, but if you’re going this route, you should probably use a payroll service to help.
What’s the tax rate? This will depend on the withholdings your nanny selects when filling out the W-4 form.
What Happens If You Don’t Pay Nanny Taxes?
This is probably the biggest question on parents’ minds once they learn they may owe taxes on their nanny’s wages. Most people don’t pay their nanny taxes and many nannies prefer to be paid under the table so their take-home wage is higher - so why would you choose to pay the taxes?
The problem with this thinking is that it puts you at a huge risk - professionally, personally, and financially - and denies nannies important benefits and resources, which we’ll get into.
First, what’s the risk to you?
There is huge financial risk to willfully avoiding taxes, which can include thousands of dollars in penalties, interest, and the tax that should have been paid in the first place.
Tax evasion can also carry jail time and, in extreme cases, a felony conviction. Most of the time the IRS will not pursue criminal penalties if the tax bill and all related penalties are paid, but the risk is there.
If you work in a profession that requires licensure that carries an ethics code (like my CPA license), you run the risk of having your license suspended or revoked, especially if you were convicted of a crime.
How would the IRS even find out?
Most likely, they wouldn’t. But consider this scenario: Your nanny no longer works for you and, months or years down the road, applies for unemployment benefits with the state. Your nanny will be asked to list employment history for a certain timeframe and he or she lists the time worked with your family. The state employment agency checks their records and sees that the wages were never reported and taxes were never paid. At that time, they can notify the IRS of a potential issue.
With unemployment rates as high as they are and with more people able to apply for state benefits through pandemic assistance programs, it is a relatively risky time to pay a nanny under the table.
Alright, enough of the scary stuff. How does your nanny benefit from being paid legally?
A legitimate employment and income history: Any time your nanny applies for an apartment lease, student loan, car loan, mortgage, or credit card, documented proof of income and/or employment is required. A W2 and paystub from a legitimate employer will satisfy these requirements; a screenshot of a Venmo account will not.
Unemployment & other state benefits: If your nanny loses a job in the future, he or she will have the opportunity to claim unemployment benefits while looking for a new job. The same goes for state programs like paid family and medical leave, short-term disability or maternity leave, or workers compensation insurance.
Retirement benefits: When your nanny retires, the amount of retirement paid out is partially based on the length of employment history and how much was contributed to these accounts by employers.
How To Pay Nanny Taxes & When To Do It
This could really use the space of an entire post, especially if you’re looking to DIY your nanny taxes. Let’s go over the basics and we’ll cover the details in an upcoming article!
FICA, FUTA & (optional) Federal Income Tax Withholdings: You will need to apply for a federal Employer Identification Number (EIN) before filing with the IRS or state agencies. This is a quick first step - we have a 3 minute video that will walk you through the process.
You’ll need to keep track of all wages paid, taxes withheld, and taxes due throughout the year. As tax time approaches, you’ll need to create and file the following forms:
Prepare a Form W-2 for your employee for the previous year’s wages and give them copies B, C, and 2 by Feb. 1 of the following tax year. FICA wages go in boxes 4 and 6. Overall wages go in box 1, and they include FICA wages. You must prepare a separate Form W-2 for each household employee if you have more than one. This is done for you if you use a payroll service.
Send Copy A of the W-2 to the Social Security Administration, along with Form W-3, which acts as something of a transmittal letter. This deadline is also Feb. 1, and you can take care of this online. The Social Security website provides instructions.
As a household employer, you’re given flexibility as to when and how you pay your taxes to the IRS. If your taxes and employee withholdings are substantial, it might make sense to make quarterly estimated tax payments so you’re not hit with a huge bill in April.
If you choose to pay it all in one lump sum at tax time, you’ll do the following:
File Schedule H, Household Employment Taxes, with your Form 1040 by April 15. If you file for an extension to file your 1040, the extension applies to Schedule H as well. This form covers FUTA taxes and any income taxes you might have withheld, along with FICA taxes. You can easily fill this out if you use a tax preparation software or you can prepare it yourself and provide it to your CPA for inclusion in your tax return.
Are There Ways to Reduce Your Nanny Tax Bill?
Fortunately, there are! We’ll go into detail about how to implement these tax strategies in next week’s blog post, but here’s the high level list of my top 5 (legal!) nanny tax savers:
Child & Dependent Care Tax Credit
Dependent Care FSA
Sweeten your offer with non-cash, non-taxable perks
Provide a transportation stipend
Offer health insurance
Looking for a little guidance on applying for tax accounts, filing your nanny taxes, and calculating your nanny's pay? We created an affordable, guided DIY service for capable parents who don't care to overpay for their nanny payroll. We love helping families get things done and save money in the process!