Hiring nannies, housekeepers, and personal chefs used to be a luxury reserved only for the wealthy. But the rise of the on-demand economy has made hiring caregivers and other household staff more accessible.
Today, it’s not uncommon for people busy with jobs or family commitments to outsource many domestic tasks. A 2017 study published in the Proceedings of the National Academy of Sciences shows that spending money on such time-saving services can promote happiness and lead to greater life satisfaction. But it can also get you into hot water if you aren’t aware of household employment taxes, also known as the nanny tax.
What Is the Nanny Tax?
The nanny tax requires people who hire a household employee to:
- Withhold taxes from the employee’s pay, including federal and state income taxes and Social Security (6.2% of wages) and Medicare taxes (1.45% of wages)
- Pay the employer’s portion of payroll taxes, including 7.65% of wages toward Social Security and Medicare (FICA), 6% of the first $7,000 of wages for federal unemployment taxes (FUTA), and any state unemployment taxes
For 2019, the nanny tax impacts anyone who pays a household employee $2,100 or more in a calendar year or $1,000 or more in a calendar quarter for unemployment taxes. For the 2020 tax year, that threshold increases to $2,200 or more in a calendar year. The quarter threshold remains at $1,000.
Who Qualifies as a Household Employee?
Despite its nickname, the nanny tax isn’t just for people who hire nannies. Household employees can include anyone who works in or around your home as an employee. It doesn’t matter whether the person works full time or part time or whether you hire them through an online platform.
Household employees can include:
- Housekeepers and maids
- Personal assistants
- Senior caregivers
Other workers that may come into your home, such as repair people, plumbers, and contractors, are not subject to the nanny tax. The IRS considers them independent contractors rather than employees because they use their own tools, dictate their own hours of availability, and decide how best to perform the work. The key to someone being a household employee is that you control not only what work they do but also how they do it.
To illustrate, say you hire a plumber to fix your leaky shower. The person lets you know when they can fit you into their schedule, brings their own tools, and generally decides the best methods for performing the repairs, though they may ask for your input if there are options. The plumber is an independent contractor. On the other hand, your wealthy uncle has a live-in housekeeper. He dictates the hours the housekeeper works, which areas of the mansion to clean and when, and provides all the necessary tools and supplies. The housekeeper is a household employee.
You don’t have to count payments made to your spouse, parent, or child under age 21.
Can My Nanny Be an Independent Contractor?
Many people prefer to classify their household workers as independent contractors to avoid the nanny tax. While that’s possible with some people you hire, nannies and other caregivers are almost always considered household employees under the law. When you hire a nanny or caregiver to work in your home, it’s hard to argue you don’t have control over the schedule they work and the duties they must perform.
On the other hand, if you hire a house cleaner, that person is probably an independent contractor if they dictate when they’re available to work, use their own tools and cleaning products, and have specific procedures for how they do their job. However, if you dictate the house cleaner’s schedule, provide the tools and cleaning products you want them to use, and control how they perform the work, the house cleaner is a household employee.
The difference can be subtle. After all, even if the person you hire is an independent contractor, you schedule an appointment and may ask them to use all-natural cleaning products or arrange the accent pillows on your bed just the way you like them. If you need more help deciding whether the person you’ve hired is an independent contractor or a household employee, check out the IRS’s resource for Understanding Employee vs. Contractor Designation.
It’s essential you understand the distinction. If you misclassify a nanny or senior caregiver as an independent contractor, the IRS can charge you with tax evasion.
How to Pay Nanny Taxes
If you’ve determined your household worker is an employee rather than an independent contractor, there are several steps you must take to manage the tax requirements.
1. Apply for a Tax Identification Number
You can use your Social Security number (SSN) for tax reporting, but most people prefer to keep their SSN private. Instead, apply for a federal employer identification number (EIN) from the IRS. You may also need a state identification number, so check with the appropriate tax agency in your state to find out how to get one.
2. Collect Necessary Forms From the Employee
Household employers must obtain completed I-9 and W-4 forms from every employee hired. You use Form I-9 to verify identity and employment eligibility. You use Form W-4 to determine how much income tax to withhold from your employee’s salary.
3. Complete a New-Hire Report
All household employers must register with their state within a certain time frame (usually 20 days) after hiring an employee. The new-hire report typically includes the name, address, and SSN of the employee.
Each state has a designated agency responsible for collecting new-hire reports. The United States Department of Health and Human Services maintains a list of new-hire reporting websites by state.
4. Set Up Payroll
Paying an independent contractor is as easy as writing a check. But you need to calculate, withhold, and remit payroll taxes for an employee.
It’s possible to calculate and pay these taxes on your own using IRS Publication 926. But getting paychecks and taxes right can be complicated. For that reason, it might be worth the cost of hiring a payroll provider like Quickbooks Payroll. They’ll be able to handle the time-consuming administrative tasks of household employment taxes and payroll.
5. Report & File Taxes
Household employers have to deal with multiple tax forms. Some you might recognize, but others might be new to you.
- Form 1040-ES. You use this form to send employee federal income taxes, employee and employer Social Security and Medicare taxes, and federal unemployment taxes to the IRS four times per year.
- Form W-2. Provide this form to your household employees by Jan. 31 of the following year. You must also file copies with the IRS, the Social Security Administration, and your state’s revenue department by the same date.
- Form W-3. This form is a reconciliation of all Form W-2s issued during the year, even if you had just one household employee. File this form with Form W-2.
- Schedule H. This is an annual reconciliation of employee withholding and the employer portion of FICA and federal unemployment taxes. Attach this form to your personal tax return, Form 1040.
Depending on the payroll service you hire, it may handle everything, including setting you up with the IRS and state agency, processing payroll and calculating taxes, and filing the proper tax forms.
How to Complete Schedule H
The first part of Schedule H asks three questions to help determine whether you must pay household employment taxes:
- Did you pay any one household employee wages of $2,100 or more in 2019 (or $2,200 or more in 2020)?
- Did you withhold federal income tax for any household employee?
- Did you pay wages of $1,000 or more in any calendar quarter to all household employees?
Your answers to these questions determine whether you need to complete Part I, skip to Part II, or not file Schedule H at all.
Use Part I of Schedule H to calculate Social Security, Medicare, and federal income taxes owed for the tax year. You need to know the total cash wages paid to your household employee during the year and how much tax you withheld from their pay.
Use Part II of Schedule H to calculate FUTA. You need to know how much you paid into your state’s unemployment fund to complete this section.
Part III & IV
Use Parts III and IV to add up the totals from Parts I and II. Then, carry the total from this section to line 7a of Form 1040, Schedule 2.
If you aren’t required to file Form 1040 because you didn’t earn enough income, you can submit Schedule H alone. Just fill out Part IV, sign the form, and mail it to the address shown in the Schedule H Instructions.
Most online tax preparation software like H&R Block or TurboTax will walk you through completing Schedule H. Still, it’s a good idea to get familiar with the form so you can ensure the software calculates your tax correctly and you don’t end up paying more than you really owe.
Whatever you do, don’t ignore your nanny tax obligations. If you hire a household employee and don’t file Schedule H with your tax return, the IRS and Social Security Administration will send you notices reminding you of the filing requirement, and you could face penalties as well.
Have you ever hired a household employee? Did you handle their payroll on your own or use a payroll service?