By: Stephanie Breedlove, Founder & CEO of Breedlove & Associates
This is the time of year when people start thinking about taxes. For most, the focus is personal income taxes – assembling a pile of documents and receipts in hopes that it will transform itself into a big refund from the IRS.
But families with a household employee (i.e. nanny, housekeeper, health aide, etc.) have another type of tax to think about – household employment taxes. Commonly called “nanny taxes,” these employer obligations are a simplified version of what all other types of employers must manage.
And like all other employment taxes, the “nanny taxes” go directly toward vital employee benefits and protections. There is a little work and a little cost for employers, but knowing that you’re taking care of the one who takes care of your family – while preventing your own tax and legal problems – makes it a worthy cause.
THE HOUSEHOLD EMPLOYER’S CHECKLIST
Assuming you paid your employee $1,800 or more during the calendar year and $1,000 or more during any of the calendar quarters, you’ll have the following federal and state obligations:
- Your state and the IRS expect you to establish yourself as a household employer by getting tax IDs and require you to file a New Hire Report with the state.
- Using a payroll calculator (we have a free one at www.breedlove.com), you should calculate the tax withholdings from your employee’s pay each pay period and provide her with a paystub and the appropriate net (take-home) pay. You’ll keep track of the wages and each of the taxes withheld – some will be federal taxes and some will be state. At the end of each quarter, all the state taxes you’ve withheld, plus your employer contribution to the state unemployment pool, will go to the state. All the federal taxes withheld, plus your contribution to Social Security, Medicare and the federal unemployment pool, will go to the IRS. (The federal payments are handled through estimated payments using Form 1040-ES).
- At the end of the year, you’ll need to prepare Form W-2 and distribute to your employee by the end of January, which she’ll use to file her personal income tax return. A common – and extremely expensive – mistake we see is families using Form 1099 to report the wages they paid. Employers use that form for independent contractors, whereas employees should be given Form W-2. The IRS considers household workers to be employees of the family and, therefore, filing Form 1099 results in a form of tax evasion called “worker misclassification.”
- Many states require you to file an Annual Withholding Reconciliation form by February 28 to summarize the state income taxes withheld from your nanny’s pay the previous year. The state uses this form to match up the tax remittances you made throughout the year on your employee’s behalf.
- You’ll file Form W-3 and Form W-2 Copy A with the Social Security Administration by February 28. These filings ensure that the employee gets the appropriate “credits,” which are used to calculate the benefits she’ll receive during her retirement years. The greater her credits, the greater her Social Security income will be.
- Finally, you’ll need to attach a Schedule H to your personal income tax return (Form 1040). The Schedule H is very important because it reports the household employer taxes you paid (Social Security, Medicare, federal unemployment), as well as the taxes you withheld from your employee’s pay (Social Security, Medicare, federal and state income tax). The total tax liability shown on your Schedule H is recorded as additional tax owed on your personal income tax return. However, the 1040-ES payments you make throughout the year offset that liability. Any underpayment or overpayment is reconciled into your refund/payment.
Good news! If you employ a nanny to take care of your children so you and your spouse can work, you may qualify for two different tax breaks that can offset most – sometimes all – of your household employer costs. The first is a Dependent Care Flexible Spending Account (FSA).
Most businesses allow their employees to contribute up to $5,000 of the pre-tax earnings to help pay for childcare expenses, which include a nanny’s wages, the employer taxes paid on those wages, any fees paid to a placement agency and any day camps. Using pre-tax earnings means you’ll have no tax liability on that portion of your income. Depending on your marginal tax rate, an FSA can save you more than $2,000 per year.
If you did not set aside money into an FSA in 2012, you can take advantage of the Tax Credit for Child or Dependent Care (IRS Form 2441). This tax credit saves families with one child up to $600 per year; families with two or more children will save up to $1,200 per year.
As you can see, there are some important responsibilities families take on when they become a household employer and there are some financial rewards in the form of tax breaks for doing so. Without the “nanny taxes,” domestic workers would be left without the critical benefits and protections that all other U.S. workers enjoy.
If you have questions or need personalized help, please don’t hesitate to call us for a free phone consultation at 1-888-273-3356. We’re here to help our fellow household employers.
Breedlove & Associates, a subsidiary of Care.com, has provided comprehensive, guaranteed service that has eliminated the work and worry for more than 25,000 families since 1992.