Hiring a babysitter, or nanny, is a great way to have in-home care for your kids while you’re working, running errands, or doing whatever it is that you need to do sans-children. What you may not know is that the IRS sometimes considers these caregivers to be “household employees”, and therefore requires employment taxes (or a “nanny tax”) to be paid for their work. Follow along as we cover what counts as a household employee, who is responsible for paying a nanny tax, how much it is, how to file and pay them, and other things to take into consideration.
Who Is Considered a Household Employee?
IRS Publication 926 defines a household employee as someone you hired to do household work and that worker is your employee. Household work is work done in and around your home, and the worker is your employee if they follow your specific instructions about household and childcare duties, and you provide the supplies they need to do their work. On the other hand, if your nanny is providing childcare at their house, they would be self-employed. Another example of a self-employed household worker is a landscaper who provides services to the general public, provides their own tools and supplies, and pays their own helpers.
The IRS provides examples for household workers such as babysitters, caretakers, housecleaners, yard workers, drivers, private nurses, and nannies, among others. It’s important to note that they don’t need to work full-time hours to be considered a household employee. Let’s say that you hired Nicole to come to your house three days a week to provide childcare and light housekeeping. Nicole follows your instructions on how to carry out these duties. Nicole is considered a household employee. Now that we know she’s an employee, what is nanny tax, and how do we determine if we must pay it for her services?
What is Nanny Tax?
The nanny tax consists of two components that, together, are often known as employment taxes. The two components are:
- Social Security and Medicare taxes, or FICA taxes – Social security tax pays for retirement, survivor benefits, and disability benefits for workers and their families. Medicare tax pays for hospital care, nursing home care, hospice care, and home health care. You will need to withhold and pay these taxes if you pay cash wages of $2,300 or more in 2021 to a household employee. Do not count wages that you pay to your spouse, your child under the age of 21, your parent, or any employee under the age of 18 any time in 2021.
- Federal Unemployment taxes, or FUTA taxes – This tax pays unemployment compensation to workers who lose their jobs. You will need to pay this tax if you pay total cash wages of $1,000 or more in any calendar quarter of 2021 to a household employee. NOTE: Depending on your state, there could also be a separate state unemployment tax. For a list of state unemployment agencies, go to oui.doleta.gov/unemploy/agencies.asp.
A third component that could come into play is federal income tax withholding. To know whether this will apply to you, make sure your household employee fills out and signs the Form W-4. The employee must give you a completed Form W-4 and you will be required to pay it to the IRS. There is a tax withholding table on the Form W-4 to help you to determine how much to withhold, and Publication 15-T has specific instructions. There could also be state and local tax withholding requirements, depending on your state.
It seems like a lot, but there are good reasons that the nanny tax exists! For the household employees, they can qualify for Social Security income and Medicare coverage when they retire. They also have an employment history that can be verified for securing loans. For you, the employer, you will have peace of mind knowing you will avoid IRS and state audits, and you could be eligible for tax breaks to offset the cost of the nanny taxes. Not paying nanny taxes will not provide any of these future benefits for your household employee and could alert the IRS and the state to audit you and charge you back taxes with penalties and interest, or even charge you with tax evasion.
You don’t want that, so let’s assume that you will pay Nicole more than $2,300 per year and more than $1,000 per quarter, so you will be responsible for FICA and FUTA taxes. What will this cost you?
Who Pays The Nanny Tax, and How Much Are They?
Nanny taxes are relatively simple to calculate. FICA taxes are 15.3% of the employee’s wages. To break this down further, you and your employee are each responsible for 7.65% of FICA tax, which is made up of 6.2% Social Security and 1.45% Medicare. If you do not withhold the employee’s half from their wages, you are responsible for paying the entire 15.3%. You do not have to continue paying into Social Security if you have paid your employee more than $142,800 in 2021, but there is no limit for Medicare.
FUTA taxes are 6% of FUTA wages, which is the first $7,000 of cash wages that you pay to a household employee. You may be able to take a credit of up to 5.4% against the FUTA tax if you pay state SUTA taxes, which would be a net of 0.6% FUTA tax for you to pay. Schedule H on Form 1040 has instructions on whether you can take the credit and if the credit is reduced for wages paid in a credit reduction state. Of course, your tax professional can help determine this for you, too.
What Do I Need to Keep Track Of?
You will likely be paying your employee on a set schedule. Let’s say you decide to pay Nicole semi-monthly (on the 15th and last day of each month). On each payday, you should record the dates and amounts of the following:
- Your employee’s cash and noncash wages (Note: non-cash wages are still taxable)
- Any employee Social Security tax and Medicare tax you withhold or agree to pay for your employee
- Any federal income tax you withhold
- Any state and local employment taxes you withhold
- Form W-4 filled out and signed by the employee
- Form I-9 Employment Eligibility Verification filled out and signed by you and the employee
How To Pay Nanny Taxes, and When?
The first step is to apply for an Employer Identification Number (EIN) if you have never paid an employee before. You will need to include this number on the forms that you file. You can apply for one at IRS.gov/EIN. If you are required to withhold either state employment tax or both state and local employment tax, and/or pay SUTA tax, you will need to register with the appropriate agencies once you have your EIN.
As you’re getting ready for tax time, you will need to prepare a Form W-2 for each household employee for the previous year’s wages. You are required to give them Copies B, C, and 2 by January 31st of the following tax year. You will need to send Copy A to the Social Security Administration, along with Form W-3. This can be completed online.
You will also need to prepare and file Schedule H (Household Employment Taxes) with your Form 1040 by the regular tax deadline. This form includes FICA, FUTA, and federal withholding income taxes, if any. This is also when those taxes are to be paid to the IRS, with any other taxes you may owe with your Form 1040. Since this is an additional cost, it’s important to figure out whether you will need to make quarterly estimated payments each year. There is a penalty and interest that you could pay if the IRS determines that you did not withhold enough taxes throughout the year. Alternatively, you can ask your own employer to withhold more federal income tax from your wages to cover the extra nanny tax you will be covering. You can do this by filling out a new Form W-4 and using the income tax table to determine how much more you will want withheld from your wages.
If you decide to make quarterly estimated tax payments, use Form 1040-ES. It includes payment vouchers to make your payment by check or money order, or you can also make payments online. For details, you can visit IRS.gov/Payments. Note that you are required to make quarterly estimated tax payments if you expect to owe at least $1,000 in tax for 2021, after subtracting your withholding and refundable credits. Your tax professional can help you determine if you should be making the quarterly payments to avoid penalties and interest. If you are subject to either state filing requirements or both state and local filing requirements, check with your state and local agencies to find out when the taxes need to be paid and how often the required reports need to be filed.
Remember to look into any state and local tax, and SUTA requirements, and use care when determining if someone working for you qualifies as a household employee or not. As always, Cerebral Tax Advisors can help you make these determinations, as well as file and pay your nanny taxes so that you’re always in compliance. It can be overwhelming to handle all the paperwork, but it doesn’t have to be with the right help!