4 nanny tax mistakes to avoid this tax season

Nannies, housekeepers, senior caregivers and other household workers are considered employees and not independent contractors. Simply put, the family is in control of when and how the work is performed. You could file Form SS-8 with the IRS to get an official determination, but during tax season you may not have much time to wait for a decision that will most likely establish that the worker is an employee. The IRS has consistently ruled this way over the years. Also, giving a nanny a 1099 and calling them an independent contractor is considered tax evasion.

This means you and your client need to follow tax, wage and labor laws. The family should get a federal employer identification number, register as an employer with their state, and file a new hire report. They will need to pay their share of Social Security and Medicare taxes (7.65 percent of gross wages) and withhold the same amount from their employee’s pay. Your client will also owe federal and state unemployment taxes.

At the end of the year, the employee gets a W-2 while the family submits a copy of the W-2 and Form W-3 with the Social Security Administration and files Schedule H with their personal tax return.

Household employees should not be paid through your client’s business. Tax deductions on a company payroll require all employees to be “direct contributors to the success of the business.” Including household workers on a business payroll is considered an illegal tax deduction.

A sole proprietor of a business or farm can report household payroll taxes on their company’s Form 941 or Form 943 for ease of filing. That does not mean they can put a household worker on their business payroll. They can just report the taxes with their business filings.

Even with this exception, and to keep it simple, it may be best to keep household payroll taxes separate from business-related taxes.

Business owners with domestic help can remit household employment taxes quarterly using Form 1040-ES and then file Schedule H with their personal tax returns while continuing to report their company taxes on Form 941.

A household employer can use a Dependent Care Flexible Spending Account offered through their job to set aside pre-tax money (up to $10,500 in 2021 under the American Rescue Plan) to help pay for childcare and reduce their taxable income. This can save a family anywhere from $3,300 to $4,700 depending on their marginal tax rate, where they live and other factors.

Wages paid to a nanny are considered a reimbursable expense under a Dependent Care FSA.

A nanny’s pay is a qualifying expense for the Child and Dependent Care Tax Credit, which also got a big boost from the latest pandemic relief legislation. The credit has increased to $8,000 for families with one child and to $16,000 for two or more children. The amount of the credit gradually decreases based on a family’s adjusted gross income, from 50 percent of qualifying expenses for households with an AGI of less than $125,000 to 1 percent for households with an AGI of $440,000.

With the American Rescue Plan, a family with an AGI between $185,000 and $400,000 can get a 20 percent credit on qualified expenses and receive $1,600 for one child and $3,200 for two or more children.