Legal Issues: Internal Revenue Service

According to the Internal Revenue Service (IRS), Nannies are employees and parents are employers. The IRS for the following reasons does not consider nannies independent contractors:

  • Nannies do not provide “project-based” work.
  • Nannies are not in control of their work, i.e., the hours, days and responsibilities of the work   they perform.
  • Nannies do not bring their own tools with them.

The IRS requires that parents who pay a Nanny more than $1,400 in a calendar year withhold taxes from her gross salary. The required tax withholdings total 7.25-11% of a Nanny’s gross salary: They include:

  • Half of a Nanny’s Social Security and Medicare costs: 7.25% of her gross income
  • State disability insurance: varies by state

Parents are not required to withhold a Nanny’s federal or state income taxes from her gross income. Nannies can elect to pay these taxes at year-end when they file their tax return. Personal income taxes can be minimal to 36% or higher based on filing status and annual gross income. Employers are also responsible for paying their portion of taxes on their Nanny’s gross salary. These include half of a Nanny’s Social Security, Medicare and Unemployment Insurance and other state employer taxes. These taxes total 9-11% of a Nanny’s gross salary:

  • Half of a Nanny’s Social Security and Medicare costs: 7.25% of her gross income
  • Federal and state unemployment insurance: 2-4% depending on the state
  • Other state taxes, such as employee training taxes or work force taxes

Many parents do not withhold taxes from their Nanny’s salary. These include well-intentioned parents who want to comply with government regulations but are caught in the web of the unregulated Nanny market.

Parents want the best care for their child. Among the candidates they must select from are the following:

  • Nannies who cannot have taxes withheld because they don’t have documentation.
  • Nannies who do not want taxes withheld in order to increase their take home pay.
  • Nannies who want their employer to pay their taxes.
  • Nannies who will pay their own taxes but charge more to cover part or all of their taxes.

Because the pool of Nanny candidates includes those unable or unwilling to pay taxes on their salary, the expected hourly rate Nannies charge is almost always quoted in terms of net hourly rate (or what a Nanny takes home after taxes). Parents who want to comply with IRS regulations must increase this hourly rate by 9-11% to cover taxes.

Parents who pay taxes on their Nanny’s salary can recover part, if not all, of their employer taxes by participating in a Dependent Care Assistance Plan (DCAP) set up and managed by their employers. The federal government allows parents to set aside up to $5,000 of pre-tax income annually in a DCAP. This tax break can recover as much as $2,000 in pretax savings, most often enough to pay the Nanny tax. Parents who do not have a DCAP available can claim a Child or Dependent Care Tax Credit on their year-end tax return. This tax credit allows 20-30% of childcare expenses up to $3,000 for one child and $6,000 for more than one child.

There are several advantages to paying taxes on a Nanny’s income. They include:

  • It eliminates the risk of getting caught. If parents are audited and found not to have paid taxes on the Nanny’s salary, they are subject to penalties and interest on the unpaid taxes. This can occur many years after a Nanny has worked for them. For example, a Nanny files for unemployment insurance and lists her previous employers. This triggers an audit of the parents and denial of coverage to the Nanny.
  • Social Security and Medicare benefits: When they retire Nannies can recover $5.00 in benefits for every $1.00 contributed during their working years.
  • Unemployment Insurance: Nannies are eligible to receive up to 50% of income for six months if they lose their job due to no fault of their own.
  • Employment History: With reportable income, Nannies can apply for a loan to purchase a car, home or pay for college and other personal expenses.

Several resources include do-it-yourself software to personalized payroll services assist parents in setting up and managing employee payroll accounts.  Chirp recommends Breedlove & Associates, the experts in the industry on nanny payroll tax services.