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Article courtesy of Breedlove & Associates Nanny Tax Preparation
Nanny Taxes-not as difficult and expensive as you may believe.
Contrary to popular belief, hiring a nanny is not like hiring an independent contractor. Rather, tax law clearly defines established household workers (such as nannies, cooks, private nurses, personal assistants, aupairs,caregivers, as "household employees." That makes you a "household employer" which means that for nanny salaries amounting to more than $1,500 (for 2006) annually, you must adhere to tax and labor laws at both the federal and state level.
But before becoming discouraged, remember that legally hiring nanny services can actually give you significant tax benefits to counterbalance the employer's tax responsibility. (For details, read our nanny tax breaks article). With this in mind, here is a concise list of tax requirements for household employers.
Nanny Employer's Tax Responsibility
This is what you will have to pay in taxes, in addition to the salary you are paying your nanny. Currently, the expected tax for a household employer is approximately 10 percent of the total amount of a nanny's wages. Social security and Medicare taxes account for most of this, with the employer responsible for paying half of the total amount (thus, 7.65% of gross wages).
Unemployment insurance at the federal level adds on an extra 0.8% for the first $7,000 in gross wages earned by the employee.
State unemployment insurance is around 2%, depending on where you live. In addition, certain states may require a small percentage for what is called Workforce Training Tax. We recommend visiting the government website of your state if you wish to obtain a more specific figure.
Paycheck Withholding for your nanny
As an employer, you are also strongly recommended to do withholding of income taxes from your nanny's paycheck, if she wants this done. While this is not technically required, it does do a service to the nanny by avoiding a large and (probably unexpected) tax obligation at the end of the year.
That said, the amount of federal and state income taxes withheld depends on how the employee chooses to fill out the W-4. Depending on where you live, additional state taxes (such as disability insurance) could also factor into withholdings.
The employee's half of Medicare and Social Security responsibility (7.65% of gross wages) should be withheld.
State and Federal Labor Law
Under federal overtime law, employees performing a nanny job must be paid 1.5 times the normal wage for every hour of work that exceeds 40 hours within a 7-day workweek. It's important to check with your state since the laws vary from state-to-state. For example, for California nannies overtime begins after an 8-hour day.
Note that live-in nannies are not covered under federal overtime law. Nonetheless, they still must be paid in full for every hour of work in which they accomplish the nanny job duties.
Federal labor law does not require paid sick days, holidays or vacation time for household employees.
Workers' Compensation for your nanny
Unlike state disability taxes and Medicare, Workers' Compensation is technically considered an insurance policy, not a tax. It is designed to provide coverage for medical expenses and lost wages cause by workplace injury or illness. It certain states it is legally required that you provide this to any household employee, including those performing nanny jobs. Fortunately, many homeowner insurance policies already contain Workers' Compensation coverage built in. But be sure to contact your insurance agent to check on your coverage. Be sure to thoroughly brush up on your state's requirements and clarify any questions by visiting the government website for your state.
Compliance
In order to comply with federal and state tax and labor law, it is necessary to complete the steps below. According to an IRS estimation, the time needed to complete the compliance process ranges from 50 to 55 hours each year.
- Sign up for both state and federal tax accounts
- Fill out a New Hire Report and submit it
- Crunch the numbers: figure out how much tax liability will be accrued throughout the year
- Put together state and federal tax returns and send in both your taxes and those of the employee (recommended to remit federal returns four times a year)
- Keep a record of state and federal withholdings, net pay and gross pay
- Keep up to date with household tax law, and respond to any IRS inquiries
Tax Breaks for nanny employers
For household employers who legally pay for nanny services, there are two important tax breaks offered by the IRS.
The first arrangement can be accomplished through creating a Dependent Care Account through your own place of work. Many employers will allow you to funnel $5,000 of pre-tax earnings into this fund, which is designated for childcare costs. Doing the math, this can amount to as much as $2,300 per year, depending on your tax bracket. This savings is usually enough to completely offset the taxes paid for being a home employer.
If your company doesn't offer the option of creating a Dependent Care Account, the IRS lets you claim Tax Credit for Child or Dependent Care. This credit, which is applied to the personal income tax return, exempts you from as much as $600 for single child or $1,200 for a household with two children or more.
More Advantages to Hiring Nanny Legally
Apart from tax breaks, legally hiring a nanny as a household employee creates greater job security for the person taking care of your children. This, in turn, helps contribute to the nanny's overall job satisfaction and stability, something that ultimately benefits you.
By being hired legally, the nanny is entitled to Social Security and Medicare upon retiring later in life. It is estimated that for every dollar that household employees pay in, they will be able to receive $5 in retirement pension and medical benefits. The household employee also receives unemployment benefits redeemable if he or she loses the job through uncontrollable circumstances. Disability benefits and Workers' Compensation cover the employee for sickness, injury and maternity.
In addition to creating a more humane work environment for your nanny, you benefit by steering clear of hefty fines (and in some cases felony charges) that can accompany what the IRS refers to as "tax evasion".
We thank Breedlove & Associates for this article. Breedlove can vastly simplify the payment of your taxes for a very reasonable fee. They're always willing to take your nanny tax calls at: 888-273-3356.
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