Do you have a household employee such as a nanny, a caregiver for an elderly relative who moved in with you during the pandemic, or a live-in housekeeper?
You may have hired somebody to help out during difficult circumstances caused by the COVID-19 mess.
Maybe that was a temporary arrangement, or maybe it has turned into a permanent one. In either case, the dreaded nanny tax issue may be in play.
The nanny tax refers to your duty to withhold and deposit a household employee’s share of Social Security and Medicare taxes on wages paid to the employee and also to deposit the employer’s share of those taxes. The employee and employer shares of Social Security and Medicare taxes are collectively called FICA tax.
You may also owe federal unemployment tax (FUTA) on wages paid to a household employee.
Finally, you may be required to withhold and deposit state income tax on wages paid to a household employee, and you may have to pay for state unemployment insurance too. Yikes!
Here, in FAQ format, is what you need to know about the federal tax issues for household employees. For any state issues, you’ll need to contact your friendly neighborhood payroll tax service or tax pro.
Do You Have a Household Employee?
Good question. The nanny tax issues covered here apply only if a household worker is your employee under the federal tax rules — as opposed to an independent contractor or somebody else’s employee.
Household Work Defined
First, let’s clarify who can potentially count as a household employee. According to IRS Publication 926, Household Employer’s Tax Guide, household employees are individuals who do household work — such as performing as a nanny, caretaker, private nurse, babysitter, housekeeper, maid, driver, or butler. Household work includes only performing services in or around your private home.
Services performed in your home that are not of a household nature, such as those provided by a private secretary, a personal assistant who does not do household chores or a tutor, aren’t considered household work. But of course, an individual who provides these types of services may be a garden-variety employee as opposed to a household employee.
The basic tax rules for garden-variety and rank-and-file employees are similar to those explained here for household employees, but there are different compliance requirements. Consult a payroll service or a tax pro if you have questions.
Household Employee Defined
According to IRS Publication 926, a person who does household work is your employee if you control not only what work is done but also how the work is done. So, if a worker regularly comes to your home on a schedule dictated by you and is supervised by you, the worker is probably an employee.
It doesn’t matter whether the work is full-time or part-time, or whether you hired the worker through an agency. But if an agency supplies the worker and controls what work is done and how it’s done, the worker is not your employee.
Yard cake workers, pool service guys, maids, and the like who provide services to the general public and just show up at your place periodically to go about their business are not your employees.
If I have a Household Employee, What Are My FICA Tax Obligations?
For 2021, the FICA tax issue arises only if you pay a household employee $2,300 or more during the year.
If you cross that threshold, the Social Security tax rate is 12.4 percent on all cash wages (including the first $2,300) up to $142,800. As the employer, you withhold 6.2 percent from the employee’s wages and pay the other 6.2 percent out of your pocket.
The Medicate tax rate is 2.9 percent on all cash wages (including the first $2.300). As the employer, you withhold 1.45 percent from the employee’s wages and pay the other 1.45 percent out of your pocket.
Finally, you must withhold the 0.9 percent Additional Medicare Tax on any wages over $200,000 paid to a household employee and deposit that tax with the feds. But you won’t need to worry about that unless you’re the greatest household employer of all time (the GHEOAT).
Exception. The FICA tax does not hit wages paid to a household employee under age 18 at any time during the year — unless providing household services is the employee’s principal occupation. If the employee is a student, providing household services is not considered to be his or her principal occupation, so there are no FICA tax concerns in that case.
What Are My FUTA Obligations?
For 2021, you owe FUTA only if you pay cash wages of $1,000 or more to a household employee during any calendar quarter this year or if you did so during any calendar quarter in 2020.
If you cross one or both of those thresholds, the FUTA for this year equals 6 percent on the first $7,000 of cash wages paid during the year. You do not pay FUTA on wages above $7,000. While the FUTA rate is generally 6 percent, you may be able to claim a credit of up to 5.4 percent against your FUTA liability.
As stated earlier, the FICA tax does not apply to a household employee under the age of 18 at any time during the year, as long as providing household services is not that person’s principal occupation. But the FUTA rules explained immediately above apply to an under-age-18 household employee regardless.
What is My Federal Income Tax Withholding Obligation?
Good news: you’re not required to withhold federal income tax from wages paid to a household employee — unless the employee asks you to do so, and you agree. In that case, the employee must give you a completed IRS Form W-4 (Employee’s Withholding Certificate) to allow you to calculate withholding amounts according to the table found in IRS Publication 15-T, Federal Income Tax Withholding Methods.
What About Noncash Wages?
For federal income tax withholding purposes (if you choose to withhold federal income tax), and for the amount of wages reported on your household employee’s Form W-2, you generally must include both cash and non-cash compensation.
You measure the value of any non-cash wages based on the fair market value of what you provide. But IRS Publication 926 says the following types of non-cash compensation don’t count as taxable wages:
- Meals you provide to the household employee at your home for your convenience
- Lodging you provide to the household employee at your home for your convenience and as a condition of employment
- For 2021, up to $270 per month for transit passes so your household employee can commute to your home
- For 2021, up to $270 a month to reimburse your household employee for parking at or near your home or at or near a location from which the employee commutes to your home.
Key point. You must count the cash that you give your household employee in place of these items as taxable cash wages. Fair enough.
Key point. Non-cash wages are not subject to FICA tax or FUTA per the applicable statutory language and IRS Publication 926. Good!
What About Wages Paid to a Relative or Child?
Unless otherwise noted, payments to the follwoung individuals for providing household services don’t count as wages for FICA tax or FUTA purposes:
- Your spouse
- Your under-age-21 child
- Your parent, unless (1) the parent cares for your child who is under age 18, or who has a physical or mental condition that requires personal care, and (2) certain other conditions apply
Wages paid by you for any reason to your spouse, under-age-21 child, or parent are exempt from FUTA.
Key point. While wages paid to the above individuals are exempt from the FICA tax and FUTA, they count as taxable wages for federal income tax purposes unless one of the other exceptions explained earlier applies.
How Do I Comply with the Nanny Tax Rules?
Let’s be honest. It’s a pain!
First, you’ll need to obtain a federal employer ID number (EIN) for FICA tax withholding and deposit purposes, FUTA payment purposes, and federal income tax withholding and deposit purposes.
You can obtain your EIN from the IRS and, if applicable, use that number to obtain a state identification number from the appropriate state tax agency. Here’s a link where you can apply for your EIN online. Or you can submit a paper IRS Form SS-4 (Application for Employer Identification Number).
Your household employee will need a tax ID number (TIN), which can be the employee’s Social Security number if the employee has one.
You must provide your household employee with a Form W-2 to report taxable wages paid during the year. The due date for the 2021 W-2 is January 31, 2022. Your employee then uses Form W-2 to file his or her Form 1040. You must send the IRS a copy of Form W-2.
The Social Security Administration (SSA) requires you to file an annual Form W-3 (Transmittal of Wage and Tax Statements) and an annual Copy A of Form W-2. Filing these forms notifies the SSA that you’ve withheld and paid FICA tax on your household employee’s wages.
Finally, file Schedule H (Household Employment Taxes) with your Form 1040. Use Schedule H to calculate your total household employment taxes (FICA tax, FUTA, and federal income tax withheld from the employee’s wages, if applicable). Report the total household employment taxes on Schedule 2 of Form 1040 (Additional Taxes).
The employment taxes are then carried from Schedule 2 to Line 23 of Form 1040 as an addition to your federal income tax liability. For the 2021 tax year, pay the amount due by April 15, 2022.
To avoid an interest charge penalty, you can pay these taxes in advance via quarterly federal estimated tax payments. Submit the quarterly payments with IRS Form 1040-ES (Estimated Tax for Individuals). For the 2021 tax year, estimated tax payments are due on April 15, 2021; June 15, 2021; September 15, 2021; and January 18, 2022.
Key point. As noted earlier, you also may be required to withhold state income tax from your household employee’s wages and pay state unemployment insurance.
What If I Don’t Withhold FICA Tax?
You have the option of paying your household employee’s share of FICA tax out of your pocket instead of withholding it from the employee’s wages.
If you choose that route (as many folks do), you increase the wages reported for federal income tax purposes on the employee’s Form W-2 by the amount you pay for the employee’s share of FOCA tax. Then you follow the rest of the drill explained above.
Can I Claim the Child and Dependent Care Credit Based on a Household Employee’s Wages?
Maybe. If you have one or more qualifying individuals under your wing, you may be eligible for the potentially lucrative child and dependent care credit (CDCC). The credit covers eligible expenses that you pay to care for one or more qualifying individuals so you can work, or if you’re married, so both you and your spouse can work.
The tax code defines qualifying individuals as your under-age-13 child, stepchild, foster child, brother or sister, or step-sibling, or a descendant of any of these individuals such as a grandchild. The individual must live in your homes for over half the year and must provide over half of his or her own support. A handicapped spouse or handicapped dependent who lives with you for over half the year also can be a qualifying individual.
Subject to dollar limitations, eligible expenses include wages paid to a nanny or another household employee who takes care of a qualifying individual so you can work. If you qualify, claim the CDCC on IRS Form 2441 (Child and Dependent Care Expenses). For 2021, the allowable credit will show up as a refundable credit on page 2 of Form 1040. You can collect a refundable credit even if you have no federal income tax liability.
For how this credit works during 2021, see ARPA Adds Dollars to the Child and Dependent Care Tax Credit.
The nanny tax rules are complicated, and complying with them can be a time-consuming nuisance.
Nobody will blame you if you hire a payroll service or a tax pro to take care of this stuff. Money well spent!
Your cleaning, lawn care, and pool people do not subject you to the nanny tax when they provide their own supplies and equipment. That’s good news.