The Nanny Tax: Who Owes It and How to Pay It
Is your household worker an employee under IRS rules?
It can come as quite a surprise if you decide to pay someone to watch your kids or to clean your home only to have the IRS tell you that this officially makes you an employer. The tax rules are complicated yet pretty point-blank: Household workers can be employees, just like that individual you pay to answer your office’s phones. They—and you—will owe employment or “nanny” taxes, and these taxes can cost you about 10% more over and above what you’ve agreed to pay for services.
The IRS Definition of “Employee”
So does this mean that all nannies are employees? Not necessarily, says the IRS, and this is where it gets complicated.
They’re not your employee if you hired them through an agency, and you pay the agency and the agency pays them. Nor are they an employee if they dictate when they do work for you and what they do while they’re working. They’re generally not considered your employee if you drop your child off and they care for the baby in their home.
Of course, dictating when and how they work is rare in the case of a nanny or babysitter, but this rule can apply in the case of other household workers, such as landscapers. Your lawn servicer would not be your employee if they show up with their own lawnmower and tools at a time that works best for them, particularly if yours isn’t the only lawn they take care of.
The landscaper is an independent contractor in this scenario, not an employee, so you’re off the hook for nanny taxes. This wouldn’t be the case, however, if you require that they show up every Monday afternoon at 2:00, that they use your equipment, and you tell them which part of your lawn or garden you want them to attend to.
Some More Exceptions
Assuming your worker is indeed an employee or an independent contractor, you don’t have to pay a nanny tax if they’re:
- Your spouse
- Your parent—with yet another exception
- Your child who’s under age 21
- A minor under the age of 18, unless the minor’s principal occupation is the service they’re providing for you and they’re not a student
The Exception for Parents
You must pay the nanny tax for your parent if two circumstances exist:
- They’re providing childcare services for your child younger than 18 or, if older, a child who suffers from a mental or physical disability that prevents self-care for at least four consecutive weeks in three months, and
- You’re divorced and not remarried, your spouse has died, or your spouse is disabled and can’t care for your child personally for at least four consecutive weeks in three months.
Both these circumstances apply. It’s not one or the other.
Social Security and Medicare (FICA) Taxes
Nanny taxes are Social Security and Medicare (FICA) taxes, and you’re legally obligated to withhold them from your employee’s earnings if you pay them $2,200 or more in calendar year 2020. The good news is that these taxes are a flat percentage, so you won’t have to do a lot of complicated calculations to figure out how much to withhold.
The bad news is that you’re responsible for paying half of them: As of 2020, you and your employee must each pay 6.2% for Social Security and 1.45% for Medicare, for a combined total of 7.65% each—or 15.4% including both your contributions. (Those percentages remain the same in 2021.) You’re not going to remit the money to the IRS right away, but you’ll probably want to put it in a separate, dedicated bank account so it’s available when it comes time to pay.
The IRS will expect you to pay the entire 15.4% if you neglect to withhold FICA taxes from your employee’s wages.
You don’t have to continue paying into Social Security after you’ve paid your employee the wage base limit, which is $137,700 in 2020 and $142,800 in 2021. Earnings over this amount are exempt from Social Security, although there’s no similar rule or limit for Medicare. Also, only cash wages are subject to FICA taxes, not the value of food, clothing, or other items you might provide; although if you give cash for these items, that is taxable.
Income Tax Withholding
Nanny taxes do not include contributions to your employee’s income taxes, nor do you have to withhold income tax from your employee’s pay unless your employee asks you to. Even then, it’s up to you to agree.
If that’s the case, you’ll have to make the correct calculations for withholding if you do agree, and you’ll have to send that money to the IRS on your employee’s behalf. IRS Publication 15-T tells you how to go about it.
Consider enlisting the help of a tax professional for income tax withholding.
Federal Unemployment Tax
Household employers are also responsible for the federal unemployment tax (FUTA) if they pay employees $1,000 or more in any calendar quarter, up to $7,000 a year. This tax works out to an additional 6% over your FICA contributions. But again, your child (under the age of 21), your parent, and your spouse are all exempt from this tax, and you don’t have to worry about it for the rest of the year after you pay your employee more than $7,000 in any calendar year.
This $1,000 earnings threshold is per quarter (every three months), not per year. Quarterly works out to January through March, April through June, July through September, and October through December.
This tax is solely on you. Your employee doesn’t have to contribute, and you won’t withhold anything toward it from their pay. But the IRS isn’t completely heartless. The FUTA tax rate can drop to just 0.6% in the form of a tax credit if you must also pay state unemployment taxes and if you do so by April 15, 2021, for the 2020 tax year. You can still claim a credit if you pay after that date, but it’s more limited.
Required Tax Forms
Of course, none of this is going to happen without a lot of paperwork. First, you’re obligated to make sure that the individual can legally work in the U.S. This means having them complete Form I-9, the Employee Eligibility Verification. This is technically a U.S. Citizenship and Immigration Services (USCIS) form, not an IRS form, and you must have the completed form in hand on the first day your employee reports for work.
Form I-9 includes a section that you must complete as well, certifying that you’ve reviewed the documents your employee submitted to you for verification of identity and employment eligibility. The form comes complete with a list of acceptable documents, one of which is a Social Security card bearing the employee’s Social Security number. It’s OK if they don’t have a Social Security card if they have sufficient other documentation to prove their identity and legal work status, but they should visit the nearest Social Security office as soon as possible to get one.
You don’t actually have to submit this form to either USCIS or the IRS, but they strongly advise that you keep it on hand in case you’re ever asked for it.
You’ll also need a completed Form W-4 from your employee if you’ll be withholding federal income tax. The information contained in this form is pertinent to calculating how much to withhold.
How to File and Pay
You’ll need an employer identification number (EIN) if you’re responsible for a nanny tax, but this doesn’t have to be a challenge. It’s a simple matter of going online and applying for one. You can also mail or fax Form SS-4 to the IRS to apply. Your EIN must appear on all tax forms you complete and submit, and it’s different from your Social Security number.
As tax time approaches, you must file and provide a variety of documents:
- 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.
- 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.
- File Schedule H, Household Employment Taxes, with your Form 1040 by April 15. You can file the schedule by itself if you don’t have to file a federal tax return, and 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.
Your portion of FICA taxes, along with the amounts you withheld from your employee’s earnings, should be paid along with any other tax you might personally owe when you file your Form 1040. They add to your tax liability. Do not pay the Social Security Administration directly. All they need is Copy A of the W-2.
You might want to pay your nanny tax in quarterly estimated payments as the year progresses, or ask your own employer to increase your withholding to cover these additional taxes. You could be subject to an underpayment penalty if you wait until you file your tax return in April.
Don’t Overlook Your State Obligations
Unfortunately, you’re not done quite yet. Reach out to your state at some point while you’re seeing to all these tasks and details. Not all states require that you pay the unemployment tax, so contact your state’s unemployment tax agency to be sure. As for income tax withholding, this can vary from state to state as well. Some states, such as Pennsylvania, exempt household employees because the federal government does, but you won’t know unless you ask.
Internal Revenue Service. “Publication 926 (2020), Household Employer’s Tax Guide.” Accessed Oct. 17, 2020.
Social Security Administration. “Household Workers,” Page 1. Accessed Oct. 17, 2020.
Social Security Administration. "Fact Sheet: 2021 Social Security Changes." Accessed Oct. 17, 2020.