You’ve decided to hire a nanny for your precious little one and the nanny has requested you pay her (or him) a salary.  But now you’re wondering, how exactly is this supposed to work?

No matter whether you are a new parent expecting your first child, or baby number three is on the way… a frequent cause of concern for many dual income households is child care when mom/dad goes back to work.  As a mom who did just that last year, I found myself navigating payroll set-up, trying to understand the tax benefits, and keeping up with many other items that are easy to forget when employing someone to care for your child.  

What are nanny taxes and when are you subject to them?

If you pay cash wages of $2,100 or more for 2019 to a “household employee” you will have to remit Nanny taxes, which are made up of multiple parts:

• Social Security and Medicare (FICA)
• Federal (FUTA) and state unemployment taxes
• Federal and State withholding

It might seem like a lot to think about already – but I’ll walk you through it step by step…Let’s dive into the various taxes.

Social Security and Medicare (“FICA”)

The Federal Insurance Contributions Act ( or “FICA”) is the payroll tax law that requires contributions from both employers and employees to help fund Social Security and Medicare. You and your employee are each responsible for paying 7.65% in taxes (6.2% goes to Social Security and the other 1.45% to Medicare.)   So, in total you will usually need to withhold 15.3% (7.65% * 2) to cover both sides. As an employer, you’ll always have to cover your 7.65%, but it’s up to you on how to handle the nanny’s portion. You can either pay your nanny’s 7.65% or choose to withhold it from her pay. If you decide to pay the nanny’s share then that amount is added into her wages so the nanny will have additional income she pays taxes on.  

Unemployment Tax

The Federal Unemployment Tax Act (FUTA) pays unemployment compensation to workers who lose their job.  Like most employers, you owe FUTA tax and state unemployment tax. The FUTA Tax is 6% of your nanny’s FUTA wages, but a credit of up to 5.4% is available for state contributions/unemployment taxes paid.  FUTA is assessed on only the first $7,000 of wages (2019 limit). In order to determine the state amount of unemployment tax, review the state unemployment tax agencies website.  

For example, I live in California where the unemployment tax rate is 3.4% on the first $7,000 in wages.  California also provides disability insurance and paid family leave benefits to eligible workers. This program is mandatory and usually funded through payroll deductions.  Thus, I pay an additional 1% for disability.

Federal and State Withholding

When it comes to withholding, you are generally not required to withhold tax from wages you pay to your nanny.  However, most nannies will probably request you do so on their behalf so they are not obligated to make estimated tax payments on their own.  If your nanny requests withholding then he or she usually needs to complete form W-4. If you agree to withhold for your nanny, then it is your responsibility to pay it to the IRS.  Later in this article I’ll cover two payroll processors that can take care of a lot of this for you.

How to Do It

There are a few ways you can calculate and remit taxes for your nanny.  The first, is to do it yourself (or have your tax preparer do it for you).  You’ll calculate household employment taxes on Schedule H of your tax return.  The amount calculated is added to your income tax. You’ll also need to issue a W-2, which is due January 31 of the following year – one copy is given to your nanny and another copy needs to be filed with the Social Security Administration.

You can also use a payroll processor to handle this for you.  The two I researched for myself were Homepay through Care.com and Sure Payroll.  I ended up using Sure Payroll because it was cheaper, although it was a bit more cumbersome to set up.  These payroll processors will calculate all of the taxes (FICA, FUTA, withholding and state unemployment) and you can set up auto pay for your nanny.  Note that with either approach the IRS will require you to obtain a tax identification number which you can apply for in minutes online.  

Are there any tax benefits?

Good news!  There are actually three potential tax benefits:

• Child Tax Credit
• Child and Dependent Care Tax Credit

The Child Tax Credit allows up to $2,000 for each qualifying child, and due to the tax law changes that went into effect in 2018, the income limitations were increased to $200k for an individual and $400k for a married couple.  

The Child and Dependent Care Tax Credit is a credit of 20% to 35% of up to $3,000 in child care and similar costs for a child under 13.  For high income earners this amount is reduced, but not completely eliminated.

Other Items to Consider

Once you hire a nanny, make sure to revisit your insurance and make any necessary updates.  The big ticket items are adding your nanny to your car insurance if she will be driving your car and adding a worker’s compensation policy to your homeowner’s policy.  Both of these policies will not only protect you, but also your nanny if something were to happen.