Do You Owe the Nanny Tax?

So, you've decided to hire a nanny. Or a babysitter, childcare provider, or mother's helper -- take your pick of job titles. This is the person who will come into your home to care for your precious children while you're working.

So many issues loom large when hiring a nanny: Everything from experience to references to supervision - hello, Webcam! - to compatibility with your kids, household, and schedule. Often the tax implications are the last thing you consider, but this omission could come back to bite you.

What is the "Nanny Tax?"

The Nanny Tax is actually more than one tax. It is a term for all the payroll taxes that you, as an employer, pay on behalf of the nanny, your employee. Employer payroll taxes include Social Security, Medicare, and federal unemployment taxes that come out of your pocket, along with correct withholding of matching Social Security and Medicare taxes from your nanny's check. You may also need to withhold federal income tax from your nanny's wages, if she requests that you do so.

Nanny taxes may also include state and local income tax withholding from your nanny's wages, as well as contributions to the state unemployment compensation fund and the purchase of Workman's Compensation insurance in case your nanny is injured on the job. Both of these come out of your pocket.

Hiring a nanny is not like slipping the teenager next door ten bucks to take your kids to the park, so you can dye your hair in peace and secrecy. Having a childcare provider who earns as little as $600 during the tax year automatically obligates you to file tax forms of some kind, even if you don't owe any nanny taxes.

Add all these taxes together, and they add significantly to the cost of having a nanny, versus using a daycare or taking your kids to a sitter's house.

Expect to pay around 15% of your nanny's gross salary in taxes.

Let's say you paid a part-time nanny a modest annual salary of about $10,000 to take care of your children in your home. (Good luck finding a nanny who will work that cheap.) Expect to send the government about $845 for Social Security, Medicare, and Federal Unemployment Tax (FUTA). Where I live, you'd contribute at least $265 to the state's unemployment compensation fund. Workman's Compensation insurance for your single employee would run you $250.

And, those amounts would be higher if you paid better (you tightwad) or had your nanny full time. You need to be fully informed about nanny taxes, both to comply with tax laws and to make a good decision on the type of daycare you can afford.

So, does the Nanny Tax apply to you?

In 2007, if the IRS considers your nanny a household employee rather than an independent contractor and you pay more than $1,600 in wages for the year, you're stuck paying nanny taxes. The IRS almost always defines nannies as household employees because the work is done in the parents' home, and the parents control what is done and how it is done and provide the tools and equipment. (Controlling how your nanny cares for your children is kind of the point of having a nanny, versus taking your children to daycare.) So for most of us, hiring a nanny means we have become household employers and we do owe nanny taxes.

It doesn't matter how your nanny is paid, whether she works part-time or full- time, or whether you got the referral through a nanny agency. It does not matter how the nanny refers to herself in a resume, or how you refer to her in an employment contract. If you control the work and how it is performed, according to the IRS the nanny is your household employee and you must pay employer taxes.

Can you get out of it?

Not likely. You may be tempted to pay your nanny "cash under the table" in order to save money and simplify your life - but if you're caught in this form of tax evasion, the penalties can be severe. How can this occur? Your nanny might need to file for unemployment or Workman's Compensation, and if you hadn't been paying in to the system, you'd be caught. She might become disgruntled and "turn you in," especially if an issue arises and you have to let her go. In addition, if you can't document your childcare expenses officially, you may miss out on some good tax deductions. It's best to pay your nanny taxes according to the law.

Nanny taxes are not an issue, by the way, when you use a daycare center that is defined as a business, where the people caring for your children are paid as employees of that business. You just write checks to the daycare center and it's their job to handle the payroll taxes. The same is true if your nanny is provided to you by an agency that pays her and determines her job responsibilities - she'll likely be considered an agency employee by the IRS.

If you take your children to the nanny's home for care, the nanny is not your household employee. She'll probably be considered an independent contractor. You'll pay her a gross wage, and she will be on the hook for all the taxes. But you'll still have to prepare Form 1099-MISC to document her income. Read the IRS' "Instructions for Form 1099-MISC", 2008, at www.irs.gov, for more information.

If you have in-home care, you can avoid nanny taxes only if your nanny is your spouse, your child under age 21, your parent (with some exceptions), or a student under age 18 (with some exceptions). In rare cases, if the nanny brings her own equipment to the job and provides the same service to other families concurrently (like an in-home physical therapist might do), the IRS might not consider this nanny to be your employee.

If you are unsure whether your nanny is your employee or an independent contractor, consult Publication 15-A, Employer's Supplemental Tax Guide, at the IRS Web site at www.irs.gov. Alternatively, you or your nanny can, but are not required to, file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. If you file this form, the IRS will determine the nanny's status for you (this can take up to six months).

Paying Your Nanny Taxes

You have two choices for dealing with nanny taxes: Hire it done, or learn to do it yourself. I won't lie - it's very complicated and there's a steep learning curve, with penalties if you get it wrong or file late. I do my nanny taxes on my own, but I cheat -- I have a friend whose husband guided me through the whole process my first time.

If you decide it's all too much, you can hire a tax accountant, or you can hook up with various services that will either set you up to do your nanny taxes, or will do them for you ongoing. There are many such services, and costs range from $400 - $890 for the services I looked at:

- The Nanny Tax Company (http://www.nannytaxprep.com/index_service.html)

- HomeWork Solutions (http://www.4nannytaxes.com/index.cfm)

- Legally Nanny (http://www.legallynanny.com/default.asp)

- Nannytax.inc (http://www.nannytax.com/)

Paying for these services adds to the total cost of having a nanny, especially if you're going to keep the service ongoing.

If you decide to tackle the nanny taxes yourself, do all the legwork before you have to write your nanny's first check. The specifics of how to file nanny taxes are beyond the scope of this article, and some of them might differ where you live. But I will provide a summary and steer you toward the resources I used to learn about nanny taxes.

First, you'll need to develop a payroll record keeping system - I used an Excel spreadsheet - to calculate withholding amounts based on your nanny's projected income, as well as the amounts you must set aside for employer taxes. You can use the spreadsheet to print a paystub for your nanny, if she wants one.

You will have to obtain employer IDs with federal, state, and local tax offices and then pay the taxes and unemployment fund contributions either annually or quarterly. Where I live, some of this can be done online. Federal taxes can be done along with your personal taxes and Schedule H - TurboTax handled this just fine for me. You'll also have to investigate getting workman's compensation insurance, and you'll have to create a W-2 for your nanny along with your other tax forms.

Resources

I dug into IRS publications available on the IRS Web site at www.irs.gov:

- IRS Publication 926

- IRS Publication 15 (Circular E) Employer's Tax Guide

- IRS Publication 15-A, Employer's Supplemental Tax Guide

I found similar instructional material at my state taxing authority Web site, but I had to call the local tax authority on the phone (they are too small an outfit to have a Web site, though they definitely wanted their money and their forms).

Is it worth it?

Many factors come into play when you are choosing the type of care that's right for you and your kids: Your career goals, whether you have to work or whether you want to work, and what type of care you want. If you have a nanny, you have to deal with her sick days, while if you send the kids to daycare you deal with their sick days. If they're in your house with the nanny while you're working, you'll probably be able to check up on them via Webcam - but at a daycare center there's the safety of many other people around. At home, your kids get one-on-one attention, while at daycare they learn to play well with others. Financially, if you have more than one child and you can get the nanny to take care of two for (nearly) the price of one, you'll be getting a bargain over most daycare prices. And on and on it goes.

In the end it's a personal decision for you and your family - but don't let the complexity of nanny taxes deter you, if you really want your own Mary Poppins. If I can figure it out, anyone can.