The decision to hire a nanny is not a simple one. Every family with children has to assess what exactly they want when it comes to career development, scheduling, finances, and recreational activities. Typically, when families do decide on utilizing the help of a nanny, that’s how they see it—someone who is helping out. But, in fact, they’re becoming an employer.
Becoming an employer is not something that families set out to do when looking for help with child care. It doesn’t take long before the overwhelm of payroll, taxes, and legal requirements sets in. It may seem like a good idea at first. Pay your nanny “under the table” and you and your nanny avoid the cost and hassle of paying taxes. However, when you take into account the financial and legal risks of avoiding taxes and the benefits of taking the proper legal steps, paying your nanny “under the table” is really just not worth it. Here’s why.
How Much is the Nanny Tax?
First things first: how much is the nanny tax? Families will pay 7.65% of their employee’s gross wages in Social Security and Medicare taxes (commonly called FICA taxes). For example, if your nanny makes $500/week, you’ll pay about $2,000 in FICA taxes for the year.
You’ll owe a small amount in federal unemployment taxes (FUTA) and state unemployment taxes (SUI), which varies by state but can typically be a few hundred dollars.
Use a nanny tax calculator to estimate your total nanny tax responsibility.
The Risk and Cost of Paying a Nanny “Under the Table”
Getting caught ignoring your nanny tax obligations will come at a significant financial cost.
1. Back Taxes
If you’re found not paying FICA taxes, not only do you need to pay back taxes, but the IRS is also authorized to penalize you up to 100 percent of the tax you owe.
2. Failure-to-Pay and Failure-to-File Penalties
Not paying unemployment taxes will mean penalties that can add up to 50% of the tax due. That’s on top of the unemployment taxes you didn’t pay.
3. Worker’s Compensation Fines
Not having required workers’ compensation insurance can result in fines around $2,000/day for every ten-day period of non-compliance (depending on your state). Additionally, the fine for a criminal conviction can range from $1,000 to $50,000.
4. Getting Audited
In short, avoiding nanny taxes is committing tax fraud. This increases your chances of getting a full IRS audit of your finances and jeopardizes your job or promotion opportunities that require a government clearance.
How to Reduce Your Nanny Taxes
There are a couple of ways to save on your child care expenses. You can use a Dependent Care FSA (Flexible Spending Account) and submit the Child and Dependent Care Tax Credit when you file your personal tax return.
1. Dependent Care FSA
The Dependent Care FSA is a flexible spending account that’s a pre-tax benefit offered by an employer and used to pay for qualified, out-of-pocket dependent care expenses—like your nanny’s wages.
How much can I contribute?
You can contribute a maximum of $5,000 to a Dependent Care FSA as an individual or as a married couple filing a joint tax return.
How does this help me financially?
By putting money into a Dependent Care FSA, you’ll reduce your overall tax obligation as funds are withdrawn from your pay and placed into your account before taxes are deducted. It lowers your taxable income (both for income and FICA taxes) so you end up paying less in taxes.
How much will I save?
How much you can save in taxes depends on your tax bracket and your state and/or local income tax rates. For example: If you max out your Dependent Care FSA contribution and have a combined (federal and state) tax rate of 35%, you could save close to $2,000 in taxes. The higher your tax rate, the more you will save as a Dependent Care FSA reduces your taxable income.
2. Child and Dependent Care Tax Credit
Once you’ve maxed out on your contributions to the Dependent Care FSA, you can claim your remaining child care expenses with this tax credit.
For Example:
The total expenses you can claim with this credit is $3,000 for one child and $6,000 for two or more children. The credit is 20% for any family earning $43,000 or more. That means the potential maximum credit is $600 (20% of $3,000) for the care of one person and $1,200 for two or more children.
The Bottom Line
When you look at the potential for fines, penalties, employee lawsuits, audits, and more, paying your nanny illegally is too big of a risk for the small amount you’d actually pay in nanny taxes. Then, by using a Dependent Care FSA and the Child and Dependent Care Tax Credit, you can put a serious dent in—and possibly eliminate—your nanny tax obligation.
Not to mention that treating your nanny as an official employee gives them the benefits of having a verifiable income and legal employment history (needed for loans, credit, social security, medicare), receiving unemployment benefits, and being eligible for a healthcare subsidy. It’s a great way to honor the person whose career is committed to the care and development of your kids.
Where to Start Paying Nanny Taxes
Understanding the importance of paying your nanny “on the books” and knowing exactly how to do it are very different things. That’s why Sittercity has partnered with GTM Payroll Services to help you remove the risks, hassles, and worries from nanny taxes and payroll. GTM handles the time-consuming administrative tasks of nanny taxes and payroll while leaving you in control to easily make any changes at your convenience.
Sittercity families get a free setup! They’ll take care of payday (live check or direct deposit), quarterly tax filings, year-end tax forms, and much more. All backed by a team of household employment experts available by phone, email, and chat. Sign up online or call (833) 796-1515 for a free, no-obligation consultation.
