The Nanny Tax

The nanny tax refers to a compilation of state and federal taxes that families who hire household employees like caregivers, personal assistants, or nannies need to pay.

They include taxes withheld from the employee, including state and federal income taxes, Medicare taxes, and Social Security.

They also include taxes paid by the employer, including federal & state unemployment insurance and Social Security & Medicare taxes.

For 2024, this threshold is $2,700 (for wages paid in 2023, the threshold is $2,600). Once that limit has been met, employer and employee shares of Social Security and Medicare taxes must be remitted. If an employee is paid $1,000 or more in a calendar quarter, then federal unemployment taxes are due. State unemployment taxes may also be required.

However, the state where you reside will determine your tax obligations, because while some states don’t have income taxes, some others have varying rules about paid and withheld taxes.

How do you define a household employee?

A household worker is defined as an employee when the employer controls what work the employee does, and how they get it done, whether part-time or full-time.

Even if the worker gets hired online, they are subject to taxes provided you pay them $2,400 or more every calendar year. Don’t mistakenly classify your nanny as an independent contractor because you could be fined for tax evasion.

However, some nannies could be qualified for independent contractors given their nature of jobs, but which one is right for your nanny, let’s find out more as we continue to review this. 

Please note that this process is required to proceed with caution as mids-categorizing an employee as a contractor can lead to unnecessary outcomes from legal and financial. Consult your tax advisor and attorney as applicable.

Which tax forms for nannies apply to you?

W-2: For Nanny Employees

If you have control over your nanny's work, such as setting their hours and tasks, they are considered an employee and should be paid using a W-2. With a W-2, you're responsible for withholding and paying Social Security, Medicare, and federal and state income taxes on behalf of your employee. You may also be required to offer benefits like workers' compensation insurance, unemployment insurance, and paid time off.}

Benefits of using a W-2:

• Compliance with tax laws

• Protection for your nanny and your family

• Ability to offer benefits

• Peace of mind for everyone involved

1099: For Nanny Contractors

If your nanny has more control over their work, like setting their hours and using their tools, they may be considered a contractor and can be paid using 1099. With 1099, you don't withhold taxes, and your nanny is responsible for paying self-employment taxes. You're also not required to offer benefits to contractors.

Benefits of using 1099:

• Lower taxes and paperwork

• Flexibility for both parties

However, it's important to note that misclassifying an employee as a contractor can have legal and financial consequences. The IRS has strict rules for determining whether someone is an employee or a contractor, and it's important to follow these rules to avoid penalties.

How do you determine if your nanny is an employee or a contractor?

The IRS looks at several factors to determine whether someone is an employee or a contractor. Here are some questions to ask yourself:

• Control: Do you control when, where, and how your nanny works? If you can dictate the nanny's schedule, tasks, and methods of performing those tasks, then the nanny is more likely to be considered an employee.

• Tools and Equipment: Do you provide your nanny with tools, supplies, or equipment? If you provide the nanny with everything they need to do their job, then they are more likely to be considered an employee.

• Payment: Do you pay your nanny a salary or an hourly wage? If you pay the nanny a regular wage or hourly wage, then they are more likely to be considered an employee. If you pay the nanny a flat fee or engagement-based rate for a set amount of duration, the nanny could be considered a contractor.

• Risk: Do you pay for their workers’ compensation insurance, health, and other benefits? Contractor typically bears more risk and liability for their work, while employees are typically protected by their employer's insurance and benefits

• Duration and Termination: Does the nanny work for an ongoing or indefinite period, or just a specific period? Do you have the right to terminate your nanny's employment? If the nanny is working for you on an ongoing basis and you can fire the nanny at will, then they are more likely to be considered an employee.

• Profit and Loss: Does your nanny have the opportunity to make a profit or loss? If the nanny can earn additional income or incur expenses in the course of performing their work, then they are more likely to be considered a contractor.

If you answered yes to most of these questions, your nanny is likely an employee and should be paid using a W-2. If you answered no to most of these questions, your nanny may be considered a contractor and can be paid using a 1099. 

For example, if a family hires a postpartum nanny to care for their child for 30 days at a set rate, and the nanny has the freedom to set her schedule and use her supplies, they may be considered a contract. 

However, it's still a good idea to consult with a tax professional or employment lawyer to ensure that you're following the rules correctly.

How do you pay nanny taxes?

The process of paying nanny taxes is divided into four, and each process is very important. 

1. Get a Tax ID number
   You need to first get your federal employer identification number from the Internal Revenue Service, and then take that number to the tax agency located in your state to get the state identification number. You need both numbers to pay your taxes.

2. Calculate payrolls and taxes
   You’ll need to carefully calculate your nanny’s gross pay alongside your employer's taxes and the taxes withheld from the nanny to make up the taxes for every payment period.

3. File yearly tax returns
   Most times, you’ll have to file quarterly tax returns, although some states ask for monthly or yearly filings. On average, you should be sending 1040 estimated payments to the IRS every quarter.

4. Fill out tax forms at the end of the year
   You should give your nanny a form W-2 yearly at the end of January to file their tax returns. It is required by the Social Security Administration that you file Form W-2 Copy A and Form W-3 to show whether you withheld taxes from your nanny and remitted from yourself during the year.

You also need to prepare and file a Schedule H alongside your federal income tax return. 

Depending on your state, you might need to summarize all the state income taxes withheld from your caregiver on an Annual Reconciliation form.

What does your nanny need to provide?

Upon employment, ensure that your nanny provides an accurately completed Form I-9 alongside proper identification, an ITIN or a Social Security number, and a completed federal W-4 form alongside a state income tax withholding form for states where this is applicable.

Are there any benefits to paying nanny taxes?

Employers who pay nanny taxes may qualify for tax breaks to cover their nanny taxes while nannies can feel more comfortable as they work. Both employer and employee won’t have to worry about being audited by the state or the IRS.

Here’s a list of some short-term benefits nannies can enjoy.

• An employment history used to get home and auto mortgage loans.

• Eligibility for health care subsidies under the Affordable Care Act.

• Medicare coverage and Social Security income after retirement.

• Unemployment benefits for job losses they’re not responsible for.

What can go wrong if you avoid paying nanny taxes?

Suppose you don’t pay taxes on your nanny’s wages and don’t withhold their taxes for payment over a few years when you relieve them of responsibilities and they file for unemployment benefits including your name as a past employer. In that case, the unemployment office will discover that you didn’t pay any tax returns.

Therefore, your former nanny will lose all benefits and have to be audited by the IRS and the state. Also, you’ll need to pay all the taxes you skipped paying over the years plus penalties for trying to cut corners.

In worst-case scenarios, you could be sued and fined for tax evasion.

When do I NOT need to pay nanny taxes?

There are some exceptions where you don't have to pay nanny taxes, even if you reach the threshold for doing so.

For example, you don't need to pay nanny taxes on wages paid to

• Your spouse

• Your child under 21

• An employee under 18, as long as their household services aren't their primary occupation. 

• Your parents, except meeting the following two situations (both a and b are required):

  • They care for your child under 18 or with a physical or mental condition for over 4 continuous weeks of care during the year, and

  • You are divorced or widowed, or your spouse is unable to care for your child for the same duration due to a physical or mental condition.

If you're not sure whether you need to pay nanny taxes, consult a tax professional or nanny tax service to ensure compliance with applicable laws and regulations.

Conclusion

When it comes to paying a nanny or postpartum nanny, understanding the tax forms available to you is important. While a W-2 is typically used for employees and a 1099 is typically used for contractors, the determination can be complex. It's always best to consult with a tax professional or employment lawyer to ensure that you're following the rules correctly and avoiding penalties.

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