Have you ever hired someone to help around the house, to watch your children, or take care of a sick relative? Does this person come to your house on a regular, recurring basis and take instructions from you about the work that needs to be done? If so, you may have a household employee and be required to pay the “nanny tax”[1].
This blog post will provide guidance on the types of taxes involved, how to pay them, who can help, and whether there are any tax benefits for you. Of course, none of that applies if you don’t have a household employee so let’s start there…
Do You Have a Household Employee?
Control is the dominant factor in determining if you have a household employee or independent contractor. If you can control when the work is done, what work is done and how it is done then you probably have a household employee. On the other hand, an independent contractor would dictate to you when they can work, how they will do the job and typically has many other customers. Since this is an area with few explicit guidelines and many shades of grey, we’ve listed some examples below to help guide you. A tax professional could provide guidance regarding your specific situation.
| Household Employee | Not a Household Employee |
| A nanny who works in your house Monday through Friday from 9AM – 5PM, you pay the nanny directly and you’ve provided guidelines as to the type of care needed. | You hire a nanny through an agency. The agency determines who comes to your house, pays the nanny, and determines the scope of work. |
| You hire a handyman who comes over every Monday to perform various tasks that you assign him. | A landscaper with hundreds of clients who comes periodically throughout the summer to cut your grass without much, if any, input from you. |
| A housekeeper who comes over every Wednesday at 9AM, uses your supplies and follows a list of instructions provided by you. | A housekeeper who comes every other week while you are at work but is not subject to a strict schedule and cleans using their own supplies. |
What Could Happen If I Don’t Pay the Nanny Tax?
There are three specific risk areas we want to highlight if you pay someone “under the table”.
- IRS Audit – If you hire someone under the table, you are at risk of audit by the IRS. This could result in the payment of not only back taxes, but interest and penalties as well.
- Workers’ Compensation Claim – If someone working in your house slips and falls, your personal assets could be at risk without proper workers’ compensation coverage.
- Lack of Employee Benefits – The person being paid “under the table” also has no employment history, won’t accrue social security benefits, or be able to access unemployment benefit coverage if you no longer need their services.
Types of Nanny Taxes
Income Taxes
You are not required to withhold federal and state income taxes from a person’s pay, but you can agree to it if they would prefer it. Either way, the income paid to your household employee is subject to federal, state and in some cases, local income taxes.
FICA Taxes
If you pay cash wages of $2,600 or more in 2023, you need to pay FICA (Social Security and Medicare) taxes. FICA taxes are 15.3% of wages split between the employer and the employee. For the employee’s share, you can either withhold their share (7.65%) from their paycheck or pay it out of your own funds.
FUTA Taxes
The federal unemployment tax (FUTA) is due if you pay cash wages of $1,000 or more per quarter. FUTA is a 6% tax on the first $7,000 of wages although you typically receive a credit of 5.4% so the net tax is only 0.6%. Only the employer pays this tax.
Other Taxes & Payments
Depending on the state you reside, you may also be required to make payments for workers’ compensation, disability insurance, and state unemployment taxes.
How Do I Set Up Payroll for a Nanny or Household Employee?
The first step is deciding whether you want to handle this on your own. If you do, the IRS provides a nice checklist of steps to follow, some of which have already been discussed.
2022 IRS Publication 926, Table 2. Household Employer’s Checklist
| When you hire a household employee: | Find out if the person can legally work in the United States.Find out if you need to withhold and pay federal taxes.Find out if you need to withhold and pay state taxes. |
| When you pay your household employee: | Withhold social security and Medicare taxes.Withhold federal income tax.Decide how you will make tax payments.Keep records. |
| By January 31, 2024: | Get an employer identification number (EIN).Give your employee Copies B, C, and 2 of Form W-2, Wage and Tax Statement.Send Copy A of Form W-2 with Form W-3 to the SSA. Don’t send Form W-2 to the SSA if you didn’t withhold federal income tax and the social security and Medicare wages were below $2,600 for 2023. |
| By April 15, 2024: | File Schedule H (Form 1040), Household Employment Taxes, with your 2023 federal income tax return (Form 1040, 1040-SR, 1040-NR, 1040-SS, or 1041). If you don’t have to file a return, file Schedule H by itself. |
Payroll Tax Service Options
If managing your own payroll tax firm seems too onerous or risky, there are several options to assist you. Below are a few examples of the types of payroll tax service options available to you.
- HomePay by Care.com – This online site is designed specifically for household employers and can handle filing obligations for a monthly fee.
- ADP – The largest payroll processing firm in the United States can also handle household employee payroll taxes. If you already use ADP and are familiar with it, this may be a good option.
- Local Accountant – If you prefer a personal approach, there are local accounting firms that specialize in it or offer it as part of their broader service options. If you already hire someone to prepare your income taxes, you can ask if they could also provide payroll tax services for your household employee.
Tax Benefits of Hiring a Nanny
If you hire a nanny to care for your children while you work, you may be eligible for the Child and Dependent Care Credit. You may also use your Dependent Care Flexible Spending Account to pay for the cost of the nanny.
If you hire someone to take care of an elderly relative who is chronically ill[2], those payments may qualify as a medical expense deduction. There are no tax benefits for hiring someone to assist you around the house with typical errands.
Conclusion
Hopefully this blog post shed some light on the nanny tax and whether it applies to you. The first step is determining if you have an employee. Remember, it is highly dependent on the level of control you have over when and how the work is done.
Once you’ve determined you have a household employee, you’ll want to decide how to handle the related tax filings. You can DIY or outsource to a local accountant or online payroll firm. While DIY is certainly cheaper, outsourcing gives you peace of mind that everything will be filed correctly.
[1] The term “nanny tax” is not exclusive to nannies but is shorthand for the taxes required if you hire any type of household employee.
[2] An individual is chronically ill if, within the previous 12 months, a licensed health care practitioner has certified that the individual meets either of the following descriptions: (1) He or she is unable to perform at least two activities of daily living without substantial assistance from another individual for at least 90 days, due to a loss of functional capacity. Activities of daily living are eating, toileting, transferring, bathing, dressing, and continence; (2) He or she requires substantial supervision to be protected from threats to health and safety due to severe cognitive impairment.
