Benefits of the Nanny Tax
Though a staggering percentage of qualified U.S. households ignore it, Americans who employ caregivers for their children and adult dependents are required by the federal government to pay employment taxes and payroll taxes for their employees.
While blowing off this responsibility might seem like an attractive option for its reduction in both taxes and accounting, the evidence suggests that paying nannies on the books benefits households and caregivers alike.
Higher standards within schools and among parents, along with recent research supporting the ability of young children to absorb early-learning concepts, have added the title of teacher to the resumes of nannies and childcare professionals.
Employers of domestic help, which also includes housekeepers, owe Medicare and Social Security taxes to the Internal Revenue Service. These levies are commonly called “nanny taxes” and are mandated because childcare professionals are almost always considered household employees rather than independent contractors who would bear more of a tax burden.
In addition, the employer must pay an equal amount of Medicare and Social Security taxes and federal and state unemployment insurance. Employers may choose to pay federal and state income taxes to streamline the tax-filing process for their nannies and can also elect to pay their employees’ shares of Medicare and Social Security, although it’s common to withhold those taxes from wages.
A 2017 Forbes article points out that failure to deposit payroll taxes with the IRS can lead to hefty fines and, in certain cases, prison time. Despite serious consequences, a 2017 study commissioned by the International Nanny Association shows that less than 6 percent of households who employ domestic help are compliant with tax requirements.
The IRS’ failure to enforce penalties on this specific type of non-compliance likely emboldens Americans to shirk their tax duties; otherwise, less folks would avoid nanny taxes based on financial and criminal risk. But when looking at the benefits of paying nannies legally, the scenario becomes more confounding.
On 2018 income tax returns, qualifying households are eligible for the child and dependent care credit, which can be as much as 35 percent on expenses of $3,000 for one child under age 13 and $6,000 for two or more children. As outlined in recent CNBC coverage, that credit ceiling amounts to $1,050 for one child and $2,100 for two or more children.
The qualifications for this tax credit include having earned income and being the custodial parent or main caretaker of the child claimed as dependent, and additional qualifications are outlined concisely in this recent article on the Intuit Turbotax website. In addition to meeting all qualifications, household employers will also be expected to complete and file all necessary forms with the IRS by federally mandated deadlines. The two forms associated with the tax credit specifically are the Schedule H and the 1040, but several other forms will be necessary in establishing employer and employee status.
Dependent care benefits are offered by some employers and may provide a larger tax break than the child and dependent care credit. These benefits are paid by an employer, deducted from employee wages or arranged in a pre-tax contribution and used to pay a caregiver or care agency. If they are available, the beneficiary may be able to exclude the benefits from reported income. A household employer can only take advantage of one of the two options, and both should be evaluated to find the best tax break for each household.
Beyond the positives appreciated by employers who pay their nanny taxes, the compliance also does a service to caregivers, as pointed out in an October blog post on the INA website, nanny.org. Treated to the rights of the American worker, nannies would have, at the least, access to Medicare and Social Security benefits and could qualify for unemployment benefits and workers’ compensation. Depending on the generosity of the employer, caregivers might even be offered health insurance, paid leave or a retirement plan.
For more insight on the nanny tax, how to comply, and how to claim tax credits, visit nanny.org.