It's often easier and more cost-effective to send your children to daycare than to pay an in-home child care provider. If you employ an in-home provider, you may become liable for paying the nanny tax, although this tax doesn't only apply to nannies. It relates to all household employees. If you have to pay the nanny tax, your employee will cost you a certain percentage more.
Employee Vs. Independent Contractor
The dividing line between employees and independent contractors is a murky area of tax law that's open to a bit of interpretation. Generally, it comes down to the control you have over your worker. If you instruct your nanny – or housekeeper or gardener – when to show up for work, what time she can leave, and what you want her to do while she's on the clock, she's your employee and you're liable for the nanny tax. If she shows up and does work for you on her own schedule, essentially supplying a service during hours she chooses, she's probably an independent contractor. You don't have to pay the nanny tax for independent contractors. If you have doubts about how to classify your worker, speak with a tax professional. If you misclassify your employee as an independent contractor and the IRS finds out, you may owe past due taxes and penalties.
Typically, you don't have to pay the nanny tax if the individual who cares for your children or mows your lawn is your spouse or your parent. You don't have to pay the tax if she's your child and under age 21, or another child under 18 who doesn't regularly work in the capacity for which you've hired her. For example, she might watch your children for you periodically, but she's a full-time student or works in another field besides child care.
The nanny tax only applies to certain income levels, but they're easy enough to surpass. If you pay your worker more than $1,800 in 2012, you're responsible for paying the tax. This limit does not change in 2013. You could reach this point in a few weeks' time if you employ someone to watch your children while you work full-time.
After you figure out whether you must pay the nanny tax, the next step becomes figuring out the rules for doing so. You must withhold FICA taxes from her pay: 6.2 percent of her wages for Social Security and 1.45 percent for Medicare as of 2013. The Social Security rate is up from 4.2 percent in 2012. You're responsible for sending this money to the IRS on your employee's behalf. You're not required by law to withhold federal income tax for your nanny or other household worker unless your employee requests it.
As the employer, you must match your worker's contributions to Social Security and Medicare. You're responsible for paying a total of 7.65 percent for Medicare and Social Security on her behalf, and this rate remains unchanged from 2012. The payment is due at the time you file your tax return. You must complete Schedule H and enter the tax you owe on Line 59a of your Form 1040. You might also have to pay federal unemployment tax, usually at the rate of .8 percent of your employee's earnings. To determine whether you're liable for this tax, add up all wages you've paid all your employees during each calendar quarter. You must pay FUTA if the total is more than $1,000 in any quarter. Other rules apply as well and the rates for FUTA are complicated, so if you think you might owe them, speak with a tax professional.
Beverly Bird has been writing professionally for over 30 years. She specializes in personal finance and w, bankruptcy, and she writes as the tax expert for The Balance.