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Insurance, Wills, Taxes: Tax Rules When You Have a Nanny

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Laura Ljungkvist

Laura Ljungkvist

Q: We're getting a nanny for our new baby and have heard a lot about how legally you must pay a "nanny tax." But we've noticed that quite a few of our friends don't actually pay it. What's the law on this?

A: "Nanny tax" is a term used to describe the employment taxes required by law if you pay someone to work in your home. "If you have a household employee, there are several tax rules that you must abide by," explains Alan Goldberg, president of NannyTax, Inc., in New York City, a national payroll-tax service that works exclusively with household employers.

The taxes fall into three categories: Social Security (FICA) and Medicare taxes, unemployment tax, and income tax, says Arthur Ellis, president of The Nanny Tax Company, a national payroll-tax service in Chicago.

For 2003, anyone who pays at least $1,400 to a babysitter who isn't a parent, spouse, child age 20 or younger, or person age 17 or younger needs to pay Social Security and Medicare taxes, according to Goldberg.

As an employer, you're responsible for paying your share and your nanny's share of Social Security and Medicare taxes, which total 7.65% of her wages from each of you. To cover the costs of paying her portion, you can withhold this amount from her salary. You must report these taxes annually with your 1040 return using a schedule H form.

In addition, you may be responsible for state and federal unemployment taxes, says Ellis. You'll owe these taxes if you pay your nanny at least $1,000 in any calendar quarter.

Depending on where you live, your nanny may owe local, state, and federal income taxes. She may want you to withhold income taxes based on the number of exemptions she declares, in which case she'll need to fill out a W-4 form. While you're not required to do this, it's a good idea, says Ellis. "This way the nanny doesn't face one huge payment at year's end," he says.

To reduce your childcare costs, find out whether your employer offers a flexible spending plan that allows you to set aside pretax childcare funds, Goldberg recommends. Or take advantage of the dependent-care tax credit. This is a credit toward taxes you owe based on how many children you have under age 13, says Ellis. It can reduce your federal taxes by $480 for one child or $960 for two or more children.

Not all employers pay their household employment taxes, but Goldberg and Ellis stress that you're breaking the law if you don't and you could face stiff penalties for noncompliance. What's more, paying the taxes allows your nanny to collect unemployment benefits if she's terminated as well as Social Security benefits when she retires.

You can find additional information in IRS Publication 926 at www.irs.gov. It lays out the rules in detail and includes a convenient state reference guide.

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Copyright © 2003. Reprinted with permission from the September 2003 issue of Child magazine.