Article courtesy of Breedlove & Associates Nanny Tax Preparation
When it comes time to decide on childcare, the household employer tax may seem prohibitive for many families. Because the IRS considers a nanny a “household employee”, hiring the services of a nanny does bring on a significant tax liability.
But before closing the door on the nanny childcare option, you should know about important tax breaks that can, in some cases, completely counter the initial tax liability. In many instances, this makes hiring nannies nearly tax-free, and it’s possible to actually earn much more tax credit than your nanny tax liability!
Here are two ways Household Employers can Receive Helpful Tax Breaks when Paying Nanny Salaries:
Create a Flexible Savings Account (FSA). Also referred to as a Dependent Care Account, this fund can be arranged with the company that employs you, provided, of course, that they participate in the program. The FSA allows you to set aside up to $5,000 of your earnings before taxes, for the purpose of covering family and dependent related expenses. Pre-tax means that none of this $5,000 can be touched by Social Security, Medicare, State or Federal withholdings. It’s completely exempt. For home employers paying a nanny to care for their child
or children, this can result in up to $2,300 of tax credit! Talk to your employer’s accounting or human resources department find out whether or not you are available for an FSA.
But while some companies don’t offer the FSA tax advantage, the IRS does grant an alternative tax credit. It is called the Child or Dependent Care Tax Credit, and is claimed on your personal income tax return by filling out IRS form 2441. This option gives you a sweeping 20% tax credit on childcare expenses (such as nannies) of up to $3,000 for one dependent. This amounts to a total possible savings of $600. For families with more than one dependent, the expense limit doubles to $6,000, making the maximum available tax credit $1,200.
A note about tax breaks: the above options are available to home employers who hire nannies for the purpose of childcare. In order to qualify, a family must be able to prove that the nanny salary is indeed a work related expense. Care for a child under 13 years old qualifies for tax credit if both parents of a two-parent household are working.
Making the Most of Tax Breaks
For families with only one dependent whose childcare expense is greater than $5,000 a year, it is wise to set up an FSA and put $5,000 into it, because this will save you from $2,000 to $2,300 a year. If for some reason you don’t qualify, then take advantage of the Child or Dependent Care Tax Credit. Note that families with one dependent cannot use both breaks.
We recommend that families with more than one dependent also fill up the FSA with $5,000 in order to get up to $2,300 in tax credit. If your childcare expenses exceed the FSA contribution, you can apply the Tax Credit toward “excess expenses” and gain an extra $200 in tax credit annually.
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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