You may have thought the only time you may need to worry about the so-called “Nanny Tax” is if you decide to run for public office and facing a pesky reporter at a political rally.
However, it’s a concern everyone needs to take seriously. If you have any household employees be aware that the IRS is stepping up its audits on those with workers in their private homes, and the penalties and taxes can add up quickly.
Next, keep in mind the “Nanny Tax” isn’t limited just to nannies; it also includes housekeepers, landscapers, and potentially your babysitter.
For these important reasons above, I urge any of you that employ 3rd parties in your home, for any type of service, that you read on further and decide what steps you should take if any.
Step 1 – Determine if the tax and reporting procedures apply to you
- This tax on household employees has sometimes been referred to as the “Nanny Tax” in the past. Know that it’s the same thing and that’s what I’m talking about here.
- It applies to housekeepers, maids, babysitters, nannies, handymen, pool boys, gardeners, or other household employees who ARE NOT independent contractors. This is the key point: “Independent Contractors” are exempt, but to qualify they will generally have their own equipment, supplies, serve multiple clients, and an entity or business.
- If they ONLY work for you they probably are not going to qualify as an Independent Contractor. See my most recent article on this topic under current law: “The Difference between Sub-Contractors and Employees.”
IMPORTANT NOTE – If your “household employee” is under age 18, or a family relative such as a parent, a spouse, or a child under age 21, you are off the hook. The law does not apply in that instance and you don’t have to withhold or match FICA taxes.
- If you paid cash wages of $2,200 or more in 2020, you must withhold and match the tax…and if you missed the deadline, get it done (more below on procedures).
- If you pay cash wages of $2,300 or more in 2021, you must withhold and match the tax (procedures below).
- If you want to read further regarding the rules and definitions on this topic, the IRS recently updated is Publication 926 (2021) Household Employer’s Tax Guide. It also has a webpage dedicated to this topic on the IRS website: Topic No. 756 Employment Taxes for Household Employees.
Step 2 – Determine and budget for how much the tax may be in your situation
Hopefully, you are reading this article before making a decision about hiring someone. This way you can calculate the ‘real cost’ and make a budget for how much you may pay and how many hours you may need them. Nonetheless, there are three (3) taxes that come into play when hiring a household employee:
- FICA (essentially Social Security and Medicare). You can either withhold 7.65% from your ‘worker’ and then match it for a total of 15.3% (so you are only out 7.65%). However, most household employers just pay the tax on behalf of the worker. Thus, for example, if you are paying your worker $4,000, and you are going to pay the whole amount on their behalf, it will cost you $612 just in FICA alone.
- FUTA (Federal Unemployment Tax). This is 6% on the first $7,000 of wages (a maximum of $420). Based on the same example above, this would be another $240 based on a $4,000 annual payment to the employee.
- SUTA (State Unemployment Tax). This tax will vary dramatically from state to state and you’ll need to research this carefully or rely on your payroll service company to determine the exact amount. I would suggest you budget on 2% in your preliminary calculations just to be safe. Based on the example of $4,000 in wages, that would be $80.
- Workers Compensation Insurance. This is an insurance policy that covers your employee and frankly, protects you! Again, states vary drastically on whether or not it’s required for a household employee and the rates for this type of insurance. However, even if your state doesn’t require it don’t avoid the topic. At least call your home insurance carrier and see if your policy even covers household employees and what may happen if they get hurt working on your property.
In summary, with a $12,000 annual wage for a household employee, you would be looking at a cost of approximately $1,978 on top of the wages (again just a ballpark estimate). That’s assuming you withhold the worker’s share of FICA from their check and don’t pay it for them (thus you’re only covering the “match”). I’m also budgeting at least $400 for a Workers Compensation premium, but then you may not need to pay WC in your state, or your homeowner’s insurance policy does the trick.
Finally, don’t forget a service provider to take care of all this mess too. I doubt you are going to want to become an accountant and payroll expert on the weekends to save a few hundred bucks (more on service providers below).
Step 3 – Gather information from your worker before they start working
Now, if you already have a household employee/employees working for you, choose a cut-off date to start fresh and with a ‘clean slate’. Typically at the beginning of a new fiscal quarter or calendar year (i.e. April 1, July 1, Oct 1, or Jan 1). Also, tell your worker they aren’t going to get paid anymore unless they get compensation ‘above the board’ and provide the information below.
- You need your worker’s address and SS#. Have the worker fill out a Federal W-4 form (PDF), and a state withholding form if your state collects income tax.
- You also need to confirm their citizenship. Have the worker fill out an Employment Verification Form I-9.
- It would also be advantageous to get their banking information for direct deposit. You may have paid them with Venmo, Paypal, Apple Pay, or cash in the past, but when you start to process payroll it’s going to be typical that you’ll need your worker’s bank account to do it.
- Finally, as an employer (like it or not), you, yourself will need a Federal Employer Identification Number (EIN). Apply for one online here.
Step 4 – Decide on a procedure to process payroll
Option A – Pay like a regular employee and use a service. Getting set up with all the identification numbers, the proper paperwork, and then cutting checks in the proper method can be a handful…not to mention when and where you need to make deposits.
As such, I highly recommend you consider a service until you get a feel for the process, and then you could consider Option B below. Now, there are a number of national services that provide different options to complete the procedure for you (your CPA/Accountant may even be able to do it for you). For example, they can do auto-deposit into the Nanny’s bank account. They can also just give you the numbers to cut your own check and simply do quarterly reports. You choose.
At the end of the year, the Nanny/Household worker will get a W-2 and the ‘Service’ will send in all the necessary payroll reports to the proper agencies.
The service I would suggest looking into is Sure Payroll, a division of Paychex. They have competitive pricing and serve all 50 states. However, please know I’m not endorsing them wholeheartedly and suggest you look at all the options out there and which service may serve you best.
Option B – Pay like a regular employee and use a service. Of course, this is the same as Option A, but you are going to have to do all the paperwork. I need to mention it because some clients, no matter what I say, are just DIYers. That’s ok…just saying. So if you’re going to go this route, I’ll just say one word: Quickbooks. They have so many bookkeeping options (desktop and online) that will help you significantly in the process. And remember, you can always go back to Option A if you have to.
Option C – Pay “like a Sub-contractor” and fill out Schedule H on your 1040. This is much simpler and in the big scheme of things and could save you the cost of a service provider in Option A. However, remember the Worker/Nanny is STILL an employee and receives a W-2. (Under no circumstance are you allowed to pay the Nanny with a 1099).
Under this option, you STILL gather all the information as an employer but avoid ‘typical paychecks’ or quarterly deposits. The main difference is that you simply give the Nanny/Worker their pay however and whenever you both agree (weekly, bi-weekly, monthly, etc), you don’t do regular payroll withholdings OR quarterly reports.
What you ARE required to fill out is Schedule H and submit it with your 1040. The bad news is at that point you will be paying the FICA ‘for’ your Nanny/Worker(s) and thus, multiply everything you paid them by an additional 7.65% at the end of the year. The FUTA, SUTA, and WC would all be the same in either Option A, B, or C).
To boil it down to the simple math, you simply consider the cost of 7.65% and compare it to the cost of payroll services. Thus, if you pay a Nanny/Worker $10,000 during the year, it would cost you an additional $765 that you would have otherwise deducted from their pay using a traditional payroll method like Option A & B. However, if your payroll service cost you $800 during the year, you would be better off to stick with Option C (holding all other factors constant).
But remember, in the end, you still need to file Schedule H on your own, or with your Accountant/CPA preparing your tax return because you skipped the typical payroll reports.
What‘s the risk with just paying cash ‘under the table’?
You may presume you can pay your nanny, landscaper, or maid “under the table” and it’s no big deal. They just want cash and don’t care…so you may think? However, there are several major concerns you may not foresee.
What if after your ‘worker’ leaves, they may file for unemployment, or for student aid to attend college, or may even want to file a tax return to get a loan. All of a sudden you are tagged by a State or Federal agency and that’s when the audit starts. Now you need to buckle up for penalties and interest on the amount of tax you should have been paying in the first place.
However, that may be the least of your worries. What happens if your household employee ends up getting hurt on your property and you should have been paying for Workers Compensation Insurance. Now you could be personally liable for a personal injury without any insurance company to back you up and you’re living in a nightmare.
Is this whole mess a tax deduction?
Sadly no. Remember, this is not a business you are running, it’s a service to help you in your personal life. I realize that having a nanny or a maid may be an absolute necessity in your life, but the IRS sees it as a luxury and certainly not a ‘business operation’, or a ‘business expense’.
If you are looking to take advantage of the Child Tax Credit, payments to a Nanny typically wouldn’t qualify for this. To learn more about the many changes with this credit, see the IRS User Guide and Child Tax Credit Update Portal.
In summary, remember to keep all of your records related to this process for up to six (6) years from the later of the due date of the return, OR the date when the tax was paid. Records should include any employee’s name, address, social security number; dates of employment; dates and amount of wages paid; dates and amounts of FICA taxes paid by you on behalf of your ‘worker’; copies of any and all forms listed above.
I realize this is a lot of information to absorb. Please give us a call if you need additional support and help on this topic. Don’t ignore the issue. That ‘worker’ may cost you A LOT more than you realized if you don’t record and report it properly.
* To sign up for Mark’s weekly Free E-Newsletter and receive his Free E-Book “The Top 10 Best Tax Saving Secrets Everyone Should Know” visit www.markjkohler2.wpengine.com.
Mark J. Kohler is a CPA, Attorney, co-host of the Podcasts “Main Street Business” and the “Directed IRA Podcast“. He is the author of the new book “The Business Owner’s Guide to Financial Freedom- What Wall Street isn’t Telling You”and, “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP, and the accounting firmK&E CPAs, LLP.