Conquering the Nanny Tax
IMGCAP(1)]Now that the school year has ended, it is time to consider child care during the summer months.
Instead of sending children to day care or summer day camp, many parents consider hiring a nanny or frequent baby sitter to watch their children. As if balancing work and childrearing is not challenging enough, if parents get outside help to care for their children at home, they will also need to understand the tax implications. Unless they are tax experts, they probably have a few questions about how to do things correctly.
If parents have a nanny or frequent babysitter watching their children at home, that person is considered a household employee if she is in charge of what work is done and how it is done (which is usually the case). It does not matter whether the person works full time or part time, or that the person was hired through an agency or from a list provided by an agency or association. It also does not matter whether the person is paid for the job or on an hourly, daily or weekly basis.
On the flipside, someone providing childcare services in his or her own home is not a household employee of the parents. Likewise if an agency provides the worker and the agency is in charge of what work is done and how it is done, the worker is not a household employee of the parents.
As a household employee, a nanny or frequent baby sitter is going to cost parents more than the rate they pay for watching their children. In addition to paying the employee’s wages, they may be required to pay household employment taxes, popularly referred to as the “nanny tax.”
The nanny tax involves two separate employment taxes. Whether the parents are responsible for either depends on the amount they pay.
First is FICA, which is Social Security and Medicare taxes. FICA is a 15.3 percent tax on cash wages that is generally split equally between the employer and employee. Parents and their household employee each pay 7.65 percent—which is 6.2 percent Social Security tax plus 1.45 percent Medicare tax.
In 2015, the IRS requires anyone with a household employee to withhold and pay FICA for any employee with annual cash wages of $1,900 or more. Once the 2015 annual cash wages reach $118,500 for a household employee, parents are not required to pay or withhold the 6.2 percent Social Security tax.
Nanny and babysitting wages are not subject to FICA if they are paid to any of the following individuals (even if the wages are $1,900 or more during the year):
A child who is under the age of 21;
A grandparent. Exception: Wages are subject to FICA if both of the following conditions apply:
A grandparent cares for a child who is either of the following:
Under the age of 18, or
Has a physical or mental condition that requires the personal care of an adult for at least four continuous weeks in the calendar quarter services were performed.
The parent’s marital status is one of the following:
Divorced and not remarried,
Widow or widower,
Living with a spouse whose physical or mental condition prevents him or her from caring for your child for at least four continuous weeks in the calendar quarter services were performed;
A household employee who is under the age of 18 at any time during the year. Exception: Wages are subject to FICA if providing household services is the employee's principal occupation. If the employee is a student, providing household services is not considered to be his or her principal occupation.
If they prefer, parents can pay a household employee's share of FICA from their own funds instead of withholding them from the employee’s wages. Any FICA paid to cover a household employee’s share must be included in the employee’s wages for income tax purposes. However, they are not counted as wages subject to either FICA or FUTA, which is the second employment tax I’ll discuss next.
FUTA is the federal unemployment tax. It is a 0.6 percent tax on cash wages that is paid only by the employer. In 2015, the IRS requires anyone with a household employee to pay FUTA for any employee with cash wages of $1,000 or more in any calendar quarter. Generally, only the first $7,000 in wages per household employee is subject to FUTA.
Nanny and babysitting wages are not subject to FUTA if they are paid to any of the following individuals (even if the wages are $1,000 or more in any calendar quarter):
A child who is under the age of 21;
The nanny tax is reported on Schedule H and is filed with the individual income tax return Form 1040. But to file Schedule H, parents first have to get an employer identification number, or EIN. The IRS wants the EIN as well as the Social Security number on the form. Therefore, as soon as parents hire a nanny or frequent babysitter, they should apply for an EIN by filing Form SS-4.
Let's not forget about state taxes for household employees. For example, if the parents live in Illinois and have a household employee, they will be subject to IL SUTA, which is Illinois state unemployment tax that is paid only by the employer. In 2015, IL SUTA will be paid for any household employee with cash wages of $1,000 or more in any calendar quarter. In 2015, only the first $12,960 in wages per household employee is subject to IL SUTA and is reported on Form UI-HA. To file UI-HA, parents must register as a household (domestic) employer by filling out and filing Form UI-1 DOM. The rate of IL SUTA is determined annually by the Illinois Department of Unemployment Security.
Parents are not required to withhold federal or Illinois income tax for their household employees. They should, however, withhold federal income tax if their household employee asks them to withhold and they agree.
A completed federal Form W-4 will be required for withholding. If parents withhold federal income tax, then they must also withhold Illinois income tax. A completed Form IL-W-4 will also be required. Federal income tax withheld will be reported annually on Schedule H (mentioned above). As long as parents are filing Schedule H, they will be allowed to file Illinois withholding income tax annually with their individual Illinois income tax return Form IL-1040.
The amount of withholding is based on the filing status and exemptions shown on the employee’s W-4 forms. Detailed instructions for calculating the amount of withholding can be found in Federal Publication 15 at www.irs.gov and Booklet IL-700-T at www.revenue.state.il.us.
Annually, parents or their accountant must prepare and distribute a Form W-2 to each household employee to whom they paid either:
Wages for which income tax was withheld;
Wages of $1,900 or more that was subject to FICA.
If you have prepared and distributed Form W-2s for your clients, you must also prepare Form W-2 Copy A and file it along with a completed Form W-3, Transmittal of Wage and Tax Statements. The IRS estimates the average family can expect to spend 50 to 55 hours per year correctly managing the tax implications of a household employee. This includes all the tax requirements listed above, as well as managing the employee’s payroll and responding to any notices sent by the IRS and tax agencies in your state.