You have just hired or are planning to employ a nanny for in-home childcare. The hiring process can be grueling to find the right caregiver for your children, especially in a tight nanny job market. But it will be worth it. Nannies will provide your child with one-on-one care and personal attention while you enjoy schedule flexibility without the hassles of daycare drop-offs and pick-ups.
You are now a household employer and have some additional responsibilities in paying your nanny and remitting employment taxes.
What does paying a nanny on the books mean?
In the world of household employment, you often hear phrases like “on the books” and “under the table.” What does it all mean?
Paying a nanny “on the books,” as opposed to “under the table” simply means you are doing things the right way and treating your nanny as a professional caregiver. You are paying them according to applicable tax, wage, and labor laws and withholding and remitting taxes appropriately.
It means you never have to worry about getting caught evading your tax obligations and paying back those taxes in addition to interest on taxes owed, fines, and penalties.
For licensed professionals, C-level executives, and those in financial industries, being charged with tax fraud can be career-threatening. A lawyer can be disbarred. A doctor can lose their license to practice. Government employees and contractors can lose their security clearances.
While you will have peace of mind, it also means you need to tackle a bit of paperwork and devote some time and effort to getting it right. The IRS estimates it takes at least 60 hours a year to manage nanny payroll and taxes on your own. Of course, you can save yourself some time and let GTM Payroll Services manage it all for you.
How do you pay your nanny on the books?
We have a nanny tax guide that walks you through the process step-by-step as well as a resource you can download – The Complete Guide to Household Payroll – to use as a reference.
The steps, in brief, are:
1. Obtain your federal employer identification number (ENN) from the IRS. 2. Set up employer accounts with your state’s tax agency. 3. File a new hire report with your state. 4. Obtain workers' compensation insurance if a policy is required in your state (optional coverage may also be a good idea). 4. Provide your nanny with Form W-4 (for their income tax withholdings) and Form I-9 (for employment eligibility verification). 5. Withhold Social Security and Medicare (FICA) taxes from each paycheck (you will pay the same amount – 7.65% in employer taxes) as well as income taxes. 6. On a quarterly basis, remit federal taxes (Social Security, Medicare, and federal unemployment) using Form 1040-ES as well as state unemployment taxes to your state tax agency. 7. By January 31, provide your nanny with Form W-2 for the previous year’s wages. Submit a copy of Form W-2 and Form W-3 to the Social Security Administration by the same date. 8. File Schedule H with your personal tax return.
What are my employer responsibilities when paying a nanny on the books?
As an employer, you are responsible for:
Your share of FICA taxes (7.65% of your nanny’s gross wages)
Federal unemployment taxes (6% of the first $7,000 in wages – which can be reduced to 0.6% or a maximum of $420)
State unemployment taxes (these vary by state but can be a few hundred dollars)
Workers’ compensation insurance (if required in your state this can be as low as a few hundred to around a thousand dollars)
Paid sick leave (if your state has a paid sick leave program, you may be required to make a small contribution)
What will it cost to pay a nanny on the books?
You can expect to pay about 10-15 percent of your nanny’s wages in taxes and other obligations like workers’ compensation.
Use a nanny tax calculator to help you determine your employer responsibility based on your nanny’s wages. Your employee can also use the calculator to determine their tax obligations and take-home pay.
What are the tax advantages of paying on the books?
So far we have talked about what you will need to pay in order to get nanny payroll and taxes right. But there are some financial advantages. In fact, paying a nanny on the books may be cheaper than paying under the table because of increases to the Child and Dependent Care Tax Credit and Dependent Care FSA contributions. Those two tax breaks can save you thousands of dollars and more than cover any nanny tax obligations.
In 2021, the maximum amount of childcare expenses (like wages paid to a nanny) you can put toward the Child and Dependent Care Tax Credit is $8,000 for one child and $16,000 for two or more children. The maximum total amount of the credit is $4,000 (50 percent of $8,000) if you have one qualifying person and $8,000 (50 percent of $16,000) if you have two or more qualifying persons. The 50 percent amount begins to phase out if your adjusted gross income is more than $125,000 and completely phases out if your adjusted gross income is more than $438,000.
In 2021, the Dependent Care FSA contribution limit increased to $10,500. Wages paid to a nanny is a qualifying expense for a Dependent Care FSA. Since these contributions are made pre-tax, they lower your taxable income and reduce your income and FICA taxes.
How much you will save depends on your tax bracket and any state and/or local tax rates. You could save anywhere from 35 to 46 percent on the funds you place in a Dependent Care FSA. That means if you have at least $10,500 in childcare expenses and max out your FSA and you could save $3,300 – $4,700.
What if my nanny does not want to be paid on the books?
To be blunt, it is not their choice. It is your decision, and you can make it a condition for employment. You have too much to risk and, besides, do you really want to start a relationship with your child’s caregiver by committing tax evasion?
Some nannies may not understand how they benefit from being paid on the books. They could just see it as taking home less money without understanding the upside of doing it the right way.
When being paid legally, nannies can receive unemployment benefits if they lose their job through no fault of their own. The pandemic hit the household employment industry very hard as parents laid off their nannies during the health crisis. Those who were paid “off the books” had difficulty obtaining unemployment – including the extra benefits provided by state and federal governments – because their nanny families had not been paying unemployment taxes.
With an employment history that “on the books” pay provides, nannies will have an easier time getting credit, loans, or a mortgage. Legal pay shows they have a job and a regular income, which can help if they want to rent an apartment.
Nannies also receive Social Security and Medicare benefits when they are older and no longer working.
How can I get caught not paying on the books?
It’s pretty easy. Consider these scenarios:
Your children are now school-aged so you no longer need a full-time nanny. You part ways amicably but they file for unemployment. However, the state labor agency has no record of their employment or your unemployment tax contributions. Expect to pay back those taxes with interest and incur fines and penalties.
Your nanny gets hurt on the job. They are going to miss work and incur medical expenses that they expect you to help cover. But you do not have the required workers’ compensation coverage. A claim is made, and you are exposed for not having a policy. Those fines can easily run tens of thousands of dollars for lack of coverage.
Your nanny becomes disgruntled over low pay and long hours. They file a wage claim with the state labor agency. You are asked to produce payroll records to prove you have been paying at least minimum wage and time-and-half for overtime. This can get messy without evidence of legal pay and may even lead to a civil lawsuit.
Getting caught is not cheap.
If the IRS finds out, you will need to pay the FICA taxes you owe, and then they can penalize you up to 100 percent on that amount.
Did not pay unemployment taxes? You will not only pay back the taxes you skipped, but penalties can also add up to 50 percent of the tax due.
A lack of workers’ compensation insurance can lead to fines of as much as $5,000 for every ten-day period of non-compliance. Each state will be a little different.
Is treating my nanny as an independent contractor the same as paying on the books?
The IRS has made it clear that nannies are employees and not independent contractors. Families control their caregiver’s schedule, determine their job responsibilities, and provide the tools and equipment to do the job.
Classifying your nanny as an independent contractor and providing them a 1099 and not a W-2 at year-end is considered tax evasion as your nanny is stuck paying both the employer and employee share of FICA taxes while you avoid your FICA, unemployment, and workers’ compensation obligations.
Reposted with a permission from GTM Payroll Services (www.gtm.com)