Smart Tax Planning

This tax credit will help offset your childcare costs — if you're honest with the IRS

Key Points
  • If you have a child under age 13 and you work, you may be eligible for the dependent care tax credit.
  • Got a nanny? You must pay her on the books and deduct the appropriate employment taxes in order to claim the credit.
  • Failure to pay withhold Social Security and Medicare taxes from your nanny’s pay could result in criminal and civil penalties.
Catherine Delahaye

If you want a tax credit for paying your nanny, you'll have to get right with the IRS first.

Hiring a caregiver for one infant child costs an average of $596 per week, according to data from Care.com. On a monthly basis, the payment is on par with many mortgages: $2,384.

Moreover, in 30 states and Washington, D.C., the annual cost of sending an infant to a childcare center costs more than annual in-state tuition and fees at a public college, Child Care Aware of America found.

Resist the temptation to sneak a cash payment to your caregiver. You're running the risk of steep penalties from the IRS, including tax evasion charges.

You've also made yourself ineligible to claim the child and dependent care tax credit, which can be valued at up to $1,050 per child under age 13 — or $2,100 for two or more kids under 13.

Nobody is immune from reprisal over failing to pay household employees the right way.

Consider the so-called Nannygate controversy back in the 1990s surrounding President Bill Clinton's picks for attorney general, Zoe Baird and Judge Kimba M. Wood. Both women came under fire for the way they hired and paid their childcare helpers.

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"Quite a few families are just really busy," said Tom Breedlove, senior director at Care.com HomePay. "They think of it as a tax thing that can be dealt with later at tax time."

"Procrastinating comes with its own set of problems," he said. "If you do it that way, you've withheld taxes improperly and failed to meet deadlines. You're in a dilemma."

Here's what you should know about paying your nanny on the books

You're an employer

One key question shapes your obligations to the IRS: Do you have a household employee?

Your caregiver is your employee if you control the work that's done and how it's performed, according to the IRS.

It doesn't matter whether the work is part-time or full-time, or whether you hired this individual through an agency.

If you paid cash wages of $2,100 or more in 2019 ($2,200 in 2020), then you are obligated to withhold and pay the Social Security and Medicare taxes. This adds up to 15.3% of wages, which you'll split with the employee.

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If you want to claim this tax credit, you have to come clean to the IRS first

If you paid total cash wages of $1,000 in any quarter of 2019 or 2020 to a household employee, you're also responsible for the federal unemployment tax of 6%.

Be aware that your state may also require you to pay state unemployment taxes.

You're also responsible for delivering a Form W-2 to your employee, detailing wages paid and taxes withheld.

Finally, you must also spell out the details on your employment taxes paid when you file your income tax return by April 15. You'll be using Schedule H to do so.

Household employers who fail to cover Social Security and Medicare levies could face back taxes, penalties and interest. If you willfully flout the law, you could face up to five years in prison.

Get on the books

If you're paying your caregiver on the books, you may be eligible for tax breaks.

For instance, if you paid someone to look after your child while you're at work, you might be able to claim the child and dependent care tax credit. This credit maxes out at $1,050 for one qualifying child under age 13 or $2,100 for two or more kids.

You'll need your caregiver's taxpayer identification number — generally their Social Security number — in order to claim the credit.

A dependent care flexible spending account can also help you offset some of your child-care expenses.

These accounts, which often are offered as a workplace benefit, allow you to contribute up to $5,000 a year per household on a pretax basis. Your child must be under the age of 13.

Paperwork in order

Getty Images

Avoid the tax headache by formalizing your relationship with your nanny from the beginning.

Draft an employment contract so that you can address sick days, vacation time and other details.

Here's the paperwork you'll need for your employee and the IRS:

Form I-9: This is used for verifying the identity and employment authorization of your worker. Your employee will need to provide documentation to prove their identity.

Form W-4: A withholding allowance certificate that you'll need from your employee if you withhold federal income taxes.

Schedule H: You'll turn in this form with your 1040 when you file your taxes. This will spell out how much you paid your employee(s) and the applicable unemployment, Social Security and Medicare taxes paid.

Consider either working with an accountant or using payroll software — such as NannyPay or HomePay — to stay on top of your tax obligations as an employer.

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