Many families have hired a nanny or tutor to help care for children while parents work and to help their kids keep learning after school or if/when schools are closed. Childcare is expensive. Average costs range from $26,072 per year in the South to $35,901 in the Northeast – not too different than a year at a public college. If you are paying for in-home childcare or considering hiring a nanny, there are some tax considerations you should be aware of.
There are some small tax breaks to offset the expense of hiring a nanny, the first is the Child and Dependent Care Credit. The credit can offset up to 35% (50% for tax year 2021) of your childcare expenses, decreased as income rises. Limits are expanded during 2021, up to $8000 is available. To qualify you must have earned income, your child needs to be under age 13, and eligible childcare expenses would include those allowing you to work or look for a job.
Another way to pay for childcare in a tax-advantaged way is with a Flexible Savings Account (FSA). Larger employers often provide access to an FSA that can be used to pay for dependent care. You can usually put up to $5000 pre-tax into an FSA account and use it to pay for child care pre-tax, including nannies, day care or summer day-camps that allow you to work. 2021 allowed for higher contributions due to COVID.
You must report the nanny’s Tax ID number to get the Child Care Credit or use the Flex Savings Account, so no cash-under-the-table babysitting allowed.
Whether you are using the tax credit or the FSA, it only helps on the first $5000, $8000, or 10,000 of nanny pay, the rest is paid out of after-tax income, and you’ll need to pay and submit taxes just like a regular employer. Those include:
- Taxes withheld from the employee: Social Security & Medicare taxes (FICA), as well as federal & state income taxes.
- Taxes paid by the you (the employer): Social Security & Medicare taxes, as well as federal & state unemployment insurance.
Yes, you have to pay a nanny W2 wages, they don’t qualify as 1099 employees. Anytime you pay someone $2,300 or more in a calendar year (2021) “nanny taxes” come into play (could also be an individual you pay to clean the house or mow the lawn).
If this sounds like a headache it is. That’s why there are a number of nanny payroll companies set up to handle everything related to compensating a household employee.
Tax obligations will vary depending on where you live. Not all states have income taxes, while others require additional taxes to be withheld from your employee, paid by you or both you and the nanny. To see the specific requirements where you live, visit this nanny tax page for your state.
Other than the tax credit and Flex Savings Accounts there are no real tax-efficient ways of paying for a nanny. Their income is not tax deductible the way that employees are deductible to businesses.
If you search for nanny payroll services quite a few come up. Investopedia lists a few examples, please research pricing, services and the user-interface before signing up.