Nanny Payroll and Taxes
Prepared specially for INA by Breedlove & Associates
Stephanie Breedlove, Founder of Breedlove & Associates
Is my worker a Household Employee or an Independent Contractor?
Most household workers are employees of the family for which they work. The difference between employees and independent contractors hinges on the amount of control one has over the worker. If the family controls work hours, work place, responsibilities, work tools (to name just a few), the worker is their employee. An independent contractor usually provides her own tools, her own place of work, sets her own hours and offers services to the general public. An independent contractor also has greater tax responsibility than an employee because they have to pay both the employee and employer taxes.
The IRS views household workers to be employees – with very few exceptions. If you’d like a formal ruling, you can obtain one from the IRS by filling out Form SS-8.
What employee taxes need to be withheld each pay period?
Your employee’s taxes usually range from 15-20% of gross wages. These include:
- Half of Social Security & Medicare (7.65%)
- Federal income taxes (based on the number of allowances chosen on Form W-4)
- State income taxes (if applicable)
Note: By law, employers are required to withhold Social Security and Medicare taxes from their employee’s salary each pay period. Withholding income taxes is optional, but it’s highly recommended so that your employee does not get surprised with a large tax obligation at year end.
Do I have taxes as an employer?
Yes. Household employers can expect to pay the following employment taxes:
- Half of Social Security & Medicare (7.65%)
- Federal and state unemployment insurance
Good News! The employer tax obligation can be largely – if not completely – offset by tax breaks.
What are my tax breaks?
To lighten the burden that falls on working parents, Congress has enacted tax benefits for families through employer-provided dependent care assistance (Dependent Care Account) and the Tax Credit for Child or Dependent Care. However, these tax breaks are only available if the employee is paid legally.
- Dependent Care Account. Most companies allow employees with child or dependent care expenses to contribute up to $5,000 of their pretax earnings to an individual Dependent Care Account. The money in this account is then used to cover childcare expenses, free of taxes. The savings are approximately $2,300 per year.
- Tax Credit. For those who don’t have access to a Dependent Care Account, they can claim the Tax Credit for Child or Dependent Care (Form 2441) on their income tax return at year-end. Basically, they can take a tax credit of 20% to 30% of qualifying childcare expenses. But only expenses of up to $3,000 for one dependent, or up to $6,000 for two or more dependents can be counted.
Note: For most families, only one of these tax savings options may be used each year. The Dependent Care Account usually provides the greater tax savings. Oftentimes, the tax savings exceed the employer’s share of the taxes – actually saving money by being legal!
Do I have to pay overtime?
According to federal law, household employees are entitled to overtime pay for all hours worked over 40 in a 7 day workweek. Overtime must be paid at 1.5 times the hourly wage. If a household employee is paid a salary, overtime should be addressed in the contract by breaking the salary into two pieces: the regular rate and the overtime rate. For example, an employee and family agree upon a gross salary of $600 per week for a 45 hour workweek. The regular rate for the first 40 hours is $12.63 per hour; the overtime rate for the remaining 5 hours per week is $18.94 per hour; and the total weekly salary is $600.
No limit is placed on the number of hours worked in a 7 day workweek, as long as the employment contract is fulfilled and the employee is fairly compensated.
Please note that most Live-In household employees do not have to be paid overtime but are entitled to the regular wage for every hour worked.
What are the requirements for vacation, holidays and sick days?
With a few local exceptions, families are not required to provide paid vacation, holidays and sick days – although most families recognize that these types of benefits help attract and retain a quality nanny.
What is Workers’ Compensation?
Workers’ Compensation is not a tax; it’s an insurance policy that provides financial assistance for lost wages and medical expense in the event of injury or illness resulting from the workplace. Every state has a workers’ compensation system, which entitles workers to prompt payment of benefits with a minimum of legal formality and expense. In return, the employee gives up the right to sue for any injuries from work related accidents – regardless of fault. Some states require household employers to carry a workers’ compensation policy and some do not. Call us at (888) 273-3356 or check with your state Worker’s Compensation office for details.
Are there tax breaks if I offer health insurance?
Yes. When a household employer contributes toward health insurance premiums, these dollars are not considered taxable income. Neither employer nor employee is required to pay taxes on these dollars. Families can choose to pay the healthcare premium directly to the health insurance company or pay indirectly by giving these dollars to their employee. In this case, the family must keep a copy of a current health insurance card on file for proof of a current insurance policy.
Can I run my nanny’s payroll through my own business?
For most businesses, it’s illegal. For Sole Proprietorships and For-Profit Farms, it’s legal but not recommended. Here’s a quick explanation.
Businesses are allowed to take tax deductions on their employee payroll expense. The logic is that employees are direct contributors to the success of the business, and therefore, the business is entitled to a tax break on its payroll investment. Unfortunately, the IRS has ruled that nannies are not direct contributors to the success of businesses, thereby making it illegal for any business to take a tax break on household employment payroll. (The IRS considers nannies to be direct contributors to the household, which means families can deduct their nanny’s wages as a childcare expense on their personal tax return).
Additionally, for most business entities, the tax reporting and remittance process does not allow for household employees. The only exceptions are Sole Proprietorships and For-Profit Farms, which are allowed to report household wages and remit household taxes on their business tax returns. (Even though they have a reporting exception, it is still illegal for Sole Proprietorships and Farms to take a business tax deduction on household employee payroll expense).
Finally, putting a household employee on the company payroll increases legal risk because, in the event of a legal dispute between employer and employee, the family’s business assets – as well as personal assets – could be exposed.
For these reasons, it is recommended that all families manage their business and household payrolls separately.
What is the process for handling payroll and taxes?
The payroll and tax process is quite detailed. Here’s an overview of what’s involved:
- Research employment tax and labor laws to understand legal obligations.
- Register for federal and state tax accounts.
- Complete and file New Hire Reporting.
- Identify and calculate taxes to withhold each pay period.
- Track gross pay, net pay and taxes withheld.
- Calculate the employer’s federal and state tax liabilities.
- Prepare state and federal tax returns quarterly and remit the employer and employee taxes.
- Prepare year-end tax documents (Form W-2, Form W-3, Schedule H and State Annual Reconciliation)
- Respond to IRS and state inquiries.
- Monitor ever changing household employment tax law.