Nanny Payroll and Taxes
Families and nannies alike often have questions about the nanny tax, and their respective responsibilities. The following FAQ is merely intended as an introduction. The INA recommends that you discuss your particular situation with a qualified, reputable professional. Several well known household payroll services are INA members, and you may also consider using your accountant or attorney as a resource.
Is a nanny a Household Employee or an Independent Contractor?
The IRS has ruled definitively that nannies and 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, and a family directly hiring a nanny to work in their home absolutely has the right and responsibility to exercise control over how the nanny performs her work. 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.
Do I need to deduct payroll taxes from my nanny’s pay?
As a household employer, you are responsible for paying to the Internal Revenue Service all Social Security and Medicare tax levies – the so-called “Nanny Taxes”. These taxes may either be deducted from the nanny’s pay, or you may agree to pay this for the nanny yourself. She may not pay her Social Security and Medicare taxes directly.
Your nanny will also pay any appropriate income taxes. You are not required to deduct these taxes; however, many families do this to make their nanny’s tax planning easier.
Your nanny’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
Nanny employers often qualify for favorable tax breaks that will largely offset their employer taxes.
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. Please note some states have stricter wage and hour rules. Overtime must be paid at no less than 1.5 times the hourly wage. While many families think of their nanny’s pay in terms of a salary, care must be taken at the time of employment to properly translate 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 (but not all) 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. The INA recommends that you consult with a state licensed insurance professional to discuss your situation and your state’s laws.
Are there tax breaks if I offer health insurance?
Generally the answer is yes – however with the Affordable Care Act’s implementation many of the methods and procedures that families must follow to maintain the favorable tax treatment of employer paid health insurance premiums are under revision. Please contact HealthCare.gov for current guidance.
Can I run my nanny’s payroll through my own business?
Sole Proprietorships and For-Profit Farms may report and pay their nanny’s payroll taxes through their regular reporting, however it is 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).
Generally, the business’ workers’ compensation insurance plan will not extend coverage to the nanny. 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 nanny taxes?
Nanny payroll and tax is detailed, and many find it complicated. Here’s an overview of what’s involved:
- Research employment tax and labor laws at the Federal and state level to understand legal obligations.
- Register for federal and state tax accounts.
- Complete and file New Hire Reporting.
- A pay rate notice may be required, detailing the hourly rate the nanny is being paid, the pay frequency and the 7 day work week.
- Identify and calculate taxes to withhold each pay period.
- Maintain records of 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.
The International Nanny Association has several reputable household payroll and tax services forms as members. You can locate these members in the Member Directory searching under business type PAYROLL AND TAX.