FAQ's - Nanny Tax Explained

When you hire someone to work in your home, the government considers you an employer. As an employer you are responsible for paying employment taxes. These employment taxes are commonly known as “nanny taxes” although they don’t only apply to nannies – they apply to anyone working in your home. This includes anyone who works in and/or around your home such as babysitters, caretakers, house cleaning workers, domestic workers, drivers, health aides, housekeepers, maids, nannies, private nurses, and yard workers. According to the IRS, a person is an employee if you’re telling them what they will do and how they will do it, as opposed to an independent contractor that you tell only what results you’re looking for. Families that misclassify their household employee as an independent contractor (by providing a Form 1099 for filing taxes) can be charged with tax evasion.

According to the IRS Household Employer’s Tax Guide, if you pay more than $2,700 annually or $1,000 a quarter to a person working in your home you need to pay employment taxes. This requires a family to withhold Social Security and Medicare and to pay a matching portion. State and federal unemployment insurance taxes may also be due.

There are two components of the “nanny tax”: the employee withholding taxes and the employer contribution. Typically, you’ll withhold Social Security and Medicare taxes and you may also withhold federal, state, and maybe city income taxes from your employee’s pay. As an employer, you’ll pay a matching portion of Social Security and Medicare as well as federal and state unemployment insurance taxes. States differ in their requirements, some don’t have income taxes while other states require additional taxes withheld.

You must file your nanny taxes by the due date. If you file after that date, you may have to pay penalties and interest.

If you’re thinking, “Why should I pay nanny taxes? No one else pays them and I’m not running for public office.” There are three reasons you should pay nanny taxes:

It’s the right thing to do – not only are you protected if audited, but your employee benefits from being paid legally. She will have a record of what she earned which is necessary when making a large purchase like a house or car or when applying for health insurance. When she retires, she may be eligible for Social Security Benefits and Medicare coverage. She may also be eligible for unemployment benefits if she loses her job through no fault of her own. Currently, she can also benefit from reduced health care costs via subsidies provided by the Affordable Care Act. The peace of mind this offers your employee is a real benefit for her and she will be better off by getting all the benefits other professionals enjoy.

Families can also benefit from doing the required tax reporting. Employers may be eligible for money saving tax breaks by paying nanny taxes. There are two strategies to reduce nanny taxes: Flexible Spending Accounts and the Child and Dependent Care tax credit. These tax breaks may offset most of the employer tax cost. See How can I save money by paying nanny taxes for more information.

The IRS will catch you. Paying your employee “under the table” is illegal. If you don’t report your household employee’s wages and don’t pay the associated taxes and you are audited, you will be subject to penalties and interest. You could be subjected to felony tax evasion charges, with possible fines and/or imprisonment! There is less worry about being audited by the IRS or the state if you just comply with the law.

See Can the IRS catch me if I haven’t paid my nanny taxes? for more information.

See What Are the Risks of Paying Your Nanny “Under the Table”? for more information.

There are a couple of liability thresholds for nanny taxes. If you pay anyone working in or around your home $2,700 or more in a year, or if you pay $1,000 in a quarter you are considered a household employer by the IRS.

If you pay an employee working in your home $2,700 or more in a year, both you and the employee must pay Social Security and Medicare taxes.

If you pay employees working in your home $1,000 or more in a calendar quarter, you must pay federal and state unemployment taxes (some states like New York have a lower threshold for unemployment tax liability).

These taxes don’t just apply to nannies. Any workers in your home who follow your instructions for performing their duties are covered by these laws. In addition to nannies, it can include babysitters, caretakers, house cleaning workers, domestic workers, drivers, health aides, housekeepers, maids, butlers, private nurses, and yard workers.

See When do I pay my nanny taxes? for more information.

Nanny taxes cost less than you think. Generally, the employer’s contribution costs about 10% of the employee’s salary*. The good news is that tax credits can offset some or all of this cost. See How can I save money by paying nanny taxes for more information.

* This estimate will vary based on actual salary, annual unemployment tax rates and wage caps for the state you live in.

You and your nanny must come to an agreement about how much pay she will receive for her work. Typically you would look at the market rate in your area, the individual’s qualifications, any benefits you are offering beyond pay and the job requirements. Only you and your nanny can resolve these issues by discussing and agreeing to them.

Once you have agreed upon the rate of pay, The Nanny Tax Company will calculate how much you should pay your employee, whether you withhold the taxes from her gross pay or if you pay her taxes on top of her net (take home) pay.

There are tax breaks available for families employing a nanny which may reduce their nanny tax costs. You may be able to use a Flexible Spending Account offered by your employer or the Child & Dependent Care tax credit. These tax breaks are only available to you if you pay your nanny legally.

The Flexible Spending Account (FSA). You may be able to withhold pre-tax money from your paycheck in order to reimburse yourself for dependent care costs. With this option, you may reduce or completely offset your nanny tax costs! Check with your employer to see if they offer this “cafeteria plan” benefit.

OR

The Child & Dependent Care tax credit. This is a credit that can reduce your federal income taxes when you file your federal tax return. In order to use this credit, you must meet certain requirements. See IRS Publication 503 for more information.

Because there are restrictions on each of these options according to federal law, you must be sure to investigate your eligibility.

YES. You don’t have to be audited in order to be “caught” by the IRS.

If your employee files for unemployment benefits after her employment with you ends and you haven’t paid your state unemployment taxes, you will have to pay all the taxes and the state unemployment office will charge you interest and penalties and will report you to the IRS.

If your employee becomes disabled, cannot work and files for social security disability benefits and you haven’t paid your employee’s Social Security and Medicare taxes, you will have to pay the taxes and will be charged interest and penalties.

If your employee files a tax return with wages from your employment and you haven’t provided a W-2 to the employee, you will have to pay the taxes and the IRS will fine and penalize you.

If both parents work and your tax return doesn’t include any available tax credits, the IRS may become suspicious and audit your tax return.

If your employee retires and applies for Social Security and Medicare benefits and you haven’t paid your employee’s Social Security and Medicare taxes, you will have to pay the taxes and will be charged interest and penalties.

There is no statute of limitations for failing to report and pay federal payroll taxes.

Federal nanny taxes (Social Security, Medicare, income taxes, and federal unemployment) are generally paid with your federal income tax return via Schedule H.

State nanny taxes (unemployment and income taxes) are generally paid quarterly, although some states have monthly or annual filing requirements.

In addition to paying taxes, you must give your employee a W-2 by January 31 and file the W-2 and W-3 forms with the Social Security Administration by January 31.

See What are the nanny tax deadlines? for more information.

You are not required to withhold these taxes unless your employee asks you to and you agree. If you do not withhold income taxes, your employee must pay these taxes to the government herself so it is very important to discuss this with your employee during your salary negotiations.

Federal and state unemployment taxes fund unemployment benefits paid to workers who have lost their jobs. Each state has a different method for determining your unemployment taxes and tax rate. If you pay state unemployment taxes, you can get a credit toward federal unemployment taxes.

The IRS and your state calculate penalties for late filings and late payments. Each state has a different schedule for penalties and interest. For example, Illinois imposes a minimum penalty of $50, plus 2% interest per month for late unemployment tax filing. Clearly, filing nanny taxes late can be very expensive.

Yes. Household employees are considered non-exempt employees and are covered by the Fair Labor Standards Act. Household employees must be paid for all hours worked and if they do not live with you, they are entitled to time and a half if they work more than 40 hours per week. If they live with you, they must be paid for all hours worked and depending on the state you live in, they may be eligible for overtime payment.

Yes as part of the New York Domestic Workers Bill of Rights, passed in November of 2010, you must pay your employee each week.

If you employ someone, even on a trial basis, you become an employer as soon as they start working for you. All wages paid to this employee must be reported.

It is unlawful to employ a person who cannot legally work in the United States. When you hire a household employee, you and the employee must each complete part of the Form I-9, Employment Eligibility Verification. You must verify that the employee is either a U.S. citizen or an alien who can legally work in this Country. You must keep Form I-9 with your other employment records.

In a nanny share, each family becomes an employer and each pays taxes on the wages they pay to the employee. There are many things to consider when starting a nanny share including where to host, vacations, sick children and the employee’s compensation so it is best that both families and the employee address this in advance. Also, the “host” family should check with their insurance agent regarding liability and any other insurance related issues.

Your employer is required to give you a form W2 by January 31st. This form will show your wages and any taxes withheld. You will use this form to file your income tax return.

In short, yes. According to the IRS, a worker is an employee if you tell them what they will do and how they will do it. It doesn’t matter if the employee works full time or part time. With an independent contractor, you tell them only what results you’re looking for. Families that mis-classify their household employee as an independent contractor (by providing a Form 1099 for filing taxes) can be charged with tax evasion.

Your household worker is not an independent contractor because you control what work is done and how it is done. As an independent contractor, the worker would make those decisions, not you.

Because it is illegal! The federal government is cracking down on misclassification of employees. It may seem easier to have your nanny act as an independent contractor but your incorrect filing may be considered tax evasion by the IRS.

It will also be worse financially for your nanny to file as an independent contractor. She will end up paying more taxes because she will be required to pay self-employment taxes. If she hasn’t been keeping up with those additional taxes all year, she could end up owing a lot of extra money when she files her income tax returns. Also, she will not be eligible for certain government benefits such as unemployment if she were to lose her job.

Register as an employer: You need both federal and state tax identification numbers to report and pay your nanny taxes. You get your federal employer identification number (FEIN) from the IRS and will use this number to obtain your state identification number from the appropriate tax agency in your state.

Payroll info: You need to accurately calculate your employee’s gross pay, calculate the amount of taxes to withhold from her pay, and track the corresponding employer taxes each pay period. (Use our nanny tax pay calculators to help.)

Filings:

You should file state tax returns, typically on a quarterly basis although some are filed monthly or annually.

You may send estimated federal tax payments to the IRS four times per year.

Forms:

You must provide your nanny with a Form W-2 by the end of January each year.

You need to file any required year-end forms with the state, as well as Form W-3 and Form W-2 Copy A with the Social Security Administration.

You need to prepare a Schedule H and file it with your federal income tax return.

Your household employee will need to provide you with a completed I-9 form and you need to review the documents the employee provides to you to ensure she is eligible to work in the US. She also needs to provide you with a completed federal W-4 form and possibly a state income tax withholding form.

If you are audited you may be charged with tax evasion. You will owe the federal and state taxes plus penalties and interest. It’s also possible that you may lose your professional license or professional credibility.

Remember, there is no statute of limitations for failing to report and pay federal payroll taxes!

The time it takes to manage your employee’s payroll and complete and file all the required forms will vary but the IRS estimates it would take taxpayers who file the Schedule H about 3 hours 51 minutes to complete this form. In addition, the IRS estimates it would take taxpayers about 2 hours and 29 minutes to prepare the W-3 and W-2 forms. Besides the federal tax requirements, each state has its own quarterly or monthly requirements which will take additional time.

To report your nanny’s wages and taxes, you’ll need certain tax forms.

Form SS-4: Fill out Form SS-4 or apply online through the IRS to obtain your federal Employee Identification Number (FEIN) which you’ll need for tax forms.

Form I-9: Have your nanny complete this form when hired and be sure she provides you with documents proving employment eligibility. There is a list of acceptable documents on the I-9 form.

Form W-2: Complete Form W-2 if you pay Social Security and Medicare wages of $2,700 or more or if you deduct income taxes from your employee’s pay. Give Copies B, C and 2 to your employee. Copy A (along with Form W-3) goes to the Social Security Administration.

Schedule H: If you pay your nanny wages of $2,700 or more or if you paid $1,000 or more in a calendar quarter you must file Schedule H with your federal income tax return 1040. If you aren’t required to file a federal income tax return, you must mail the Schedule H to the IRS along with your payment

Form 1040: When you file your federal tax return, attach Schedule H to Form 1040. Pay the taxes due by April 15.