Learn About Hiring a Nanny and Employment Taxes
Tips for the Household Employment Taxes
Individuals may need to pay employment taxes if they hire nannies, babysitters, butlers, chauffeurs, housecleaners and similar professionals providing domestic services. Household employment taxes (more commonly known as the "nanny tax") consist of the employer’s paid share of Social Security and Medicare taxes, taxes withheld from the worker's pay, and other payroll-related taxes such as unemployment insurance.
"If a family pays an employee $1,900 or more in a calendar year, then they are officially a household employer with an employee, and they need to withhold Social Security and Medicare and pay employer taxes," says Eva MacCleery, a nanny tax expert, and director of client service at Care.com HomePay.
This $1,900 threshold applies for the calendar year 2015. For the year 2016, the threshold is $2,000. In Tax Topic 756, the IRS writes:
"If you pay cash wages of $2,000 or more for 2016 (this threshold can change from year to year) to any one household employee, you generally must withhold 6.2% of social security and 1.45% of Medicare taxes (for a total of 7.65%) from all cash wages you pay to that employee. You also must pay your share of social security and Medicare taxes, which is also 7.65% of cash wages. (Cash wages include wages you pay by check, money order, etc.) Unless you prefer to pay your employee's share of social security and Medicare taxes from your own funds, you should withhold 7.65% from each payment of cash wages you make."
Is Your Helping Hand an Employee?
The best way to figure out if you are responsible for paying household employment taxes, MacCleery advises, is to ask yourself the following three questions:
- "What types of duties the worker is performing, are they of a household nature?"
- "Who controls the way the work is performed?" and finally
- "Will I pay this person 1,900 dollars or more per year?" ($2,000 for 2016)
Defining “Household Nature”
Work of a “household nature,” includes services rendered in the following professions:
- House cleaning,
- Domestic workers,
- In-home health care,
- Private nurses, and
- Yard workers.
How much control do you have over the work that your household professional does in your home? Is the worker performing services in an independent capacity or working as an employee? Who controls the work?
"The worker is your employee if you can control not only what work is done, but how it is done," the IRS says in Publication 926, Household Employer's Tax Guide. MacCleery elaborates, "you are a household employer when you have the right to control when, where, how, and by whom the work should be performed."
If it's not clear if the worker is an employee or an independent contractor, then "you can have the IRS give you a formal ruling," says MacCleery; "you can fill out a Form SS-8 answering about 20 questions, send it off to the IRS describing the nature of the work, and the IRS will get back to you with a formal ruling."
The Process for Handling Household Employment Taxes
Once families pay household employees $2,000 or more per year (for 2016), "they have the same obligations as a business," MacCleery says. "The employee fills out a W-4; the family withholds taxes, provides paystubs, [and] files taxes on a quarterly basis, just like a business."
Step 1: Set a Budget
A budget will take into account all the costs associated with employing household workers. This includes gross pay plus employer-only taxes. You may also want to subtract out any tax breaks, such as dependent care flexible spending accounts or the child and dependent care tax credit.
Step 2: Sign an Employment Contract With the Household Employee.
There's a sample contract on the Care.com HomePay site at https://www.care.com/homepay/sample-nanny-contract-1309060137
Step 3: Register With the IRS and State
You'll need to set up any payroll and employment tax accounts. You'll need an employer identification number so that your payroll taxes can be processed correctly.
Step 4: Set up Payroll
This includes the frequency of pay (such as weekly, biweekly, or semi-monthly), setting up software for payroll accounting, and setting up direct deposit and processes for issuing paystubs. Tax returns are filed on a quarterly basis. At the end of the year, the family issues a Form W-2 to employees to report their annual wages and tax withholdings. And finally, a Schedule H is filed with the Form 1040 to summarize the annual payroll taxes. Families can hire an accountant to help them set up their payroll processes and prepare their filings throughout the year.
Step 5: Stick to the Deadlines
Deadlines "are tailored to each client," MacCleery says. The IRS and "some states want the tax payments more frequently when the tax payments are bigger." There are deadlines for paying taxes and deadlines for filing returns. Figure out what deadlines apply to your situation.
How Household Employment Taxes Benefit the Employee
Household employment taxes benefit the employee "because she now has job history," MacCleery says. The employee becomes "entitled to important benefits such as Social Security and Medicare at retirement, and unemployment if laid off due to no fault of her own." MacCleery notes that domestic workers are eligible for disability insurance in five states, providing the workers with coverage if they are unable to work due to injury or illness.
Benefits to the Employer - Reducing Risk and Penalties
The core benefit of paying your household professional properly is that household employers reduce their audit risk, including worker misclassification risks.
What's at stake? Consider this hypothetical scenario: suppose a family misclassifies their worker as an independent contractor and issues the worker a 1099-MISC instead of a W-2. "Families feel like they are doing the right thing by using a tax form," such as the 1099-MISC, MacCleery says, "but now the employee has to pay both halves of FICA. If the worker is truly an employee then the family should be paying their share of FICA plus unemployment taxes."
State agencies work closely with the IRS on worker misclassification issues. So if one agency gets wind of a worker being misclassified as an independent contractor, they can share the information with the other agency to work on those cases together. "What we see is the employee loses job and goes to file an unemployment insurance claim. The state agency has no record (of earnings), so then (the) state does an audit with the family, and the family has to file retroactive tax returns," MacCleery explained.
Benefits to the Employer - Tax Incentives
But there's another benefit for household employers. "In addition to the peace of mind, they will likely qualify for a tax credit," MacCleery says. The household employer could take the child and dependent care tax credit on their personal 1040. For taxpayers with adjusted gross income over $43,000, the child care credit is worth 20% of child care expenses, with a maximum tax credit amount of $600 for families with one child or $1,200 for families with two or more children.
Furthermore, if the taxpayer has a child care flexible spending account at their job, they could shelter up to $5,000 of pre-tax wage income through a dependent care flexible spending account.
Now, these two tax breaks are coordinated with each other. For taxpayers who have access to a dependent care FSA, the preferred strategy is to max out their dependent care FSA ($5,000). If the taxpayer has two or more children, they would then use the next $1,000 of child care expenses as part of their child care tax credit, resulting in a $200 tax credit.
"That’s the most efficient split," MacCleery says; "only split it that way if the family has two or more dependents. Otherwise, the best bet is to use $5,000 to the dependent care account and not taking the child care credit. If for some reason you don’t have access to a dependent care account, then you can fall back on child care credit by itself."
"It's not as expensive to pay legally once you take all the tax breaks into account," MacCleery said.
Household Employment Tax Link Directory:
On the IRS.gov Website
- Publication 926, Household Employer's Tax Guide
- Tax Topic 756, Employment Taxes for Household Employees
- Schedule H (Form 1040), Household Employment Taxes
- Publication 15 (Circular E), Employer's Tax Guide
- Hiring Household Employees
- Family Caregivers and Self-Employment Tax
- Tax Topic 602, Child and Dependent Care Credit
- Publication 503, Child and Dependent Care Expenses
- Form W-10, Dependent Care Provider's Identification and Certification (pdf, includes instructions)
- Form 2441, Child and Dependent Care Expenses
- Internal Revenue Manual, 20.2.12, Penalties and Interest on Employment Taxes
First published March 27, 2015. Revised April 20, 2015.