Employer Tax FAQ - What you should know when hiring a nanny
Article courtesy of Breedlove & Associates Nanny Tax Preparation
Find answers to your nanny and household employee tax questions below:
Are nannies household employees or independent contractors?
The IRS has clearly ruled that the majority of jobs within the home, including nanny positions, are classified as employment. This means that in most cases nannies cannot legally work as independent contractors.
The definition of a household employee is someone who works under controlled conditions set forth by the family. These conditions include the place of work, the hours worked and the responsibilities. Necessary tools and supplies for the job are provided by the employer. In addition, the family incurs tax liability and any legally required benefits, and often must be responsible for withholding taxes.
An independent contractor, on the other hand, is fully responsible for the work conditions as well as the taxes. Nanny jobs seldom, if ever, meet this specification.
The IRS allows you to confirm the status of your household worker. After having the worker fill out form SS-8, you can send it in to the IRS. They will give you a formal ruling on the status of your worker.
What taxes do I withhold from the nanny's salary each month?
The tax accrued by the nanny usually amounts to about a fifth of his or her gross wage. It includes the employee's half of Social Security and Medicare (7.65%) plus applicable state and federal income taxes. Note that in some states there is income tax. The amount of federal tax withheld depends on the nanny's exemptions claimed on form W-4.
The only legally required withholdings are Social Security and Medicare. The IRS strongly recommends withholding the other taxes so that the employee doesn't face hefty tax debt at the end of the year.
Will I be taxed for being an employer?
Yes. Employment taxes for providing a nanny job include half of the Social Security and Medicare, plus state and federal unemployment insurance.
Do I get any tax breaks?
Yes. There are up to two tax breaks that household employers can take advantage of in order to offset the costs of paying taxes on nanny salaries. The first is a Dependent Care Account, or Financial Savings Account (FSA). This fund, which is established through your own employer (if your company participates in the program), allows you to earmark up to $5,000 in pre-tax earnings. For families who fully utilize the Dependent Care Account, tax savings can run up to $2,300. For certain income brackets, this completely offsets the tax liability of hiring a nanny.
The other option is an IRS tax credit for approximately 20%, and sometimes 30%, of all childcare expenses up to $3,000 per year for families with one dependent. For families with more than one dependent, the tax credit applies to $6,000 in annual childcare costs. Maximum savings, therefore, fall around $1,200. IRS Form 2441 is where you can claim the Tax Credit for Child or Dependent Care.
Can I use both tax credits in one year?
No, not usually. When given the option, the Dependent Care Account is often a better deal. Families with more than one dependent may be able to supplement this account with the tax credit for additional savings. Check with the IRS.
Do I pay my nanny overtime?
Nannies, like other household employees, are entitled to overtime pay under federal law. Overtime is considered any time over 40 hours within a 7-day workweek. The rate per each overtime hour is 1.5 times the normal wage. Be sure to check your state's legal requirements, because they may be more stringent than the Federal law.
Nanny salaries must factor in overtime. For instance, if a nanny were to agree to a 45-hour week, at a salary of $600 per week, the normal hourly wage would break down to $12.63 per hour. The 5 overtime hours would be calculated at $18.94 per hour.
Federal labor law places no cap on the number of hours worked per week, provided that the number of weekly work hours corresponds to the employment agreement.
Do live-in nannies get overtime?
It depends on where you live. All live-in nannies must be paid for each hour worked. Some states including MA, MD, ME, MN, and NY, for example, also require that live-in nannies be paid overtime at the rate of time-and-a-half for each hour worked over a specified number (usually 40 or 44, although in MN it is 48) in a 7-day period. Check your state's employment laws to determine whether or not you are required to pay your live-in nanny overtime.
Do I have to pay overtime on holidays?
There is no federal requirement to pay household employees overtime when they work on holidays.
Do I have to pay for vacation and sick leave?
While nannies may take vacations and sick days off, federal law does not require them to be compensated for these periods.
What is Workers' Compensation?
It is important to understand that Workers' Compensation is a state-administered employee insurance system, and not a tax regulated by the IRS. Workers' Compensation is for employees who fall ill on the job or get injured while working. It allows them to quickly access benefits required to pay for necessary medical care. While it is an added expense, Workers' Compensation benefits employers by requiring employees to agree not to sue for job-related injury and illness. Check with your state's Workers' Compensation office to find out if you, as a household employer, are required to provide Workers' Compensation insurance for your au pair or nanny.
Does offering health insurance provide tax benefits?
Yes. Every dollar you pay toward health insurance benefits for your household employee can be deducted from your taxable income. You are not required to pay taxes on it, nor is your employee.
How do I pay an employees health insurance?
There are two ways to provide a nanny or au pair with health insurance, and count the expense as tax-deductible. The first option is paying a health insurance company directly. The second option is to pay the employee directly. In this case, however, it is required that you keep a copy of the employee's current insurance policy on file, in order to prove the tax-deductible expense.
I own my own business. Can my nanny count as a company employee?
No. The IRS makes a clear distinction between household employees and company employees. Compensating a nanny through your business's payroll is therefore illegal. Companies are allowed to write off some or all of the cost of hiring employees, because the workforce inherently helps promotes the success of the business. Since a nanny does not contribute to the success of the company, this individual cannot be counted as an employee for company tax purposes. That said, the expense of hiring a nanny for the household does qualify the family for personal tax breaks.
How do I manage taxes and payroll for my nanny?
Here are some important steps to take when accounting for household employment:
- Fill out and submit a New Hire Report
- Sign up for tax accounts at both federal and state levels
- Compile and send in federal and state tax returns. It’s suggested that you remit the federal tax return four times a year.
- Figure out how much taxes are owed throughout the year
- Keep a record of state and federal withholdings, net pay and gross pay
We thank Breedlove & Associates for this article.