Nanny Taxes: What Parents Need to Know

With summer just around the corner, many parents are looking to hire help to watch their children during the day, and in most cases, this means Uncle Sam will also get involved.

If you hire any household help--a cook, nanny, housecleaner, gardener--and if you pay this person more than $1,800 for the year, you are required to withhold Social Security and Medicare taxes and report the wages on Schedule H of your Form 1040. You are also required to kick down the employer’s share of payroll taxes.

You can avoid the payroll tax issue if you hire someone through a bona fide agency and make payments to the agency. However, when it comes to in-home child and dependent care, you will be hard-pressed to find an agency that offers this benefit. Agencies normally help you find a caregiver and negotiate the contract, but beyond that, the family has full responsibility for maintaining the contract and handling the payroll processing.

According to Stephanie Breedlove, head of Care.com HomePay,http://www.breedlove.com/WelcomeCareMembers.aspx, “there are two truths and one lie when it comes to hiring a summer nanny to work in your home.” The first truth is that your summer nanny is not an independent contractor--the IRS does not allow that designation. Nannies must be classified as employees; as such, their wages are subject to payroll taxes. It doesn’t matter if you have a written or verbal agreement with the nanny to pay cash or to treat him or her as an independent contractor. Consenting adults is not a concept the IRS recognizes, it has its own set of criteria to which you must adhere to or be penalized.

The second truth is that you get a tax credit for hiring a summer nanny. Most people think they don’t have any tax breaks because it’s just a temporary hiring. However, according to Breedlove, if you work for a large employer, they may provide a dependent care flexible savings account (FSA). You use pre-tax dollars to pay for the nanny which can save you up to $2,300 per year if you max out your contribution. It is dependent upon your tax bracket as well.

If this is not available, you can take the dependent care tax credit which is smaller, but still significant. You may receive a credit of up to $600 with one child and $1,200 for two or more children. Check with your tax professional to determine qualification and to find out how much you may receive. “You must pay the nanny on the books in order to qualify. This is the best tax break,” says Breedlove.

Now for the big lie: According to Breedlove, many parents mistakenly think they can pay a nanny in cash because he or she is short term or temporary.  That is not the case.  You would think that a short term or temporary employee, or one who is working on a trial basis can be paid as an independent contractor. But that is not the case. Social Security and Medicare taxes must be withheld and matched.