Share this content
A young caregiver plays with two small children
iStock_fizkes_nanny with kids

5 Ways to Help Clients Reduce Their Nanny Taxes

by

Clients who employ a caregiver in their home for their kids or an elderly adult may need to pay the "nanny tax." Here, Guy Maddalone, founder and CEO of GTM Payroll Services, explains why the nanny tax matters and offers five strategies for reducing or even eliminating what your client owes in taxes for household workers.

Apr 6th 2022
Share this content

When a family hires someone to work in their home, like a nanny, housekeeper or senior caregiver, they become an employer and have employment tax obligations. 

These are commonly called “nanny taxes” and include the employer portion of FICA (Social Security and Medicare) and federal and state unemployment insurance. The family may also need to make small contributions to a state-mandated paid leave program. All told, most household employers pay about 9-12 percent of their worker’s gross wages in nanny taxes.

Now, the good news! Here are five ways to help your client reduce – and possibly cover in its entirety – their nanny tax responsibility.

1. Dependent Care Flexible Spending Account (FSA)

A Dependent Care FSA – offered through your client’s employer – sets aside pretax money to help pay for qualified out-of-pocket childcare costs like wages paid to a nanny. Your client can contribute up to $5,000 as an individual or as a married couple filing jointly, or $2,500 for a married person filing separately. That means, for a married couple, each parent can contribute $2,500 to their own Dependent Care FSA. Since these contributions are made pre-tax, they reduce your client’s taxable income. 

Depending on where your client lives and their tax bracket, it’s estimated they can save 32-45 percent on the money they contribute to their FSA. For example, if a married couple from New York that has taxable income of $350,000 and is filing a joint return puts the maximum amount into their FSAs, they can save about $2,300 on their childcare costs.*

2. Child and Dependent Care Tax Credit

The wages paid to a nanny are also a qualified expense for the Child and Dependent Care Tax Credit. For the 2022 tax year, the Child and Dependent Care Tax Credit returns up to $3,000 in expenses for a family with one child and $6,000 for families with two or more children. Families with an adjusted gross income of $43,000 or more can take 20 percent of their expenses as a credit. That means $600 for one child or $1,200 for two or more children.

Your client can’t use the same expense for both a Dependent Care FSA and the Child and Dependent Care Tax Credit. If they have $5,000 in childcare expenses and are reimbursed through a Dependent Care FSA, they would not be able to claim the Child and Dependent Care Tax Credit.

However, if they have childcare costs leftover after maxing out their Dependent Care FSA, they can claim those expenses with the tax credit. For example, if a family paid their nanny $11,000 or more and has at least two kids, they can be reimbursed $5,000 through their Dependent Care FSAs and then claim $6,000 with the Child and Dependent Care Tax Credit.

3. Qualified Small Employer Health Reimbursement Arrangement (QSBERA)

By offering pre-tax health benefits to their nanny, your client can reduce their nanny taxes. Not only does the caregiver receive health benefits, but they will also see a reduction in their taxes. It’s a win-win.

A QSEHRA reimburses a household employee for health insurance coverage purchased on the individual market or through the healthcare exchange and/or for out-of-pocket medical, dental and vision expenses.

Your client can fund the QSEHRA with up to $5,450 for a nanny who is single and $11,050 per employee with a family. Those contributions are not taxed for the family or their employee.

Your client would cut their nanny’s gross wages by the amount they contribute to a QSEHRA. This reduces their taxable income, decreasing the amount your client owes in FICA taxes.

For example, a family hires a nanny to work 40 hours/week at $20/hour. Based on the caregiver’s gross wages of $41,600, your client would owe $3,182 in FICA taxes.

Let’s take the same scenario but instead your client offers a total compensation package of $36,150 in wages and $5,450 contributed to the employee’s QSEHRA. The family would owe $2,765 in FICA taxes, which is a savings of $417.*

Keep in mind when offering a total compensation package that household employees still need to be paid an hourly rate of at least the prevailing minimum wage, which is the highest of the federal, state or local rate.

4. Educational expenses and student loans

Your client can make tax-free payments of up to $5,250 per year toward their worker’s qualified educational expenses such as tuition and textbooks. Through 2025, student loans are also considered a qualified educational expense. The CARES Act of 2020 temporarily expanded the law to include student loan repayment assistance as a qualified educational expense. The 2021 stimulus package extended this provision through 2025.

This tax-saving benefit is ideal if your client employs a college student or recent graduate. Like a QSEHRA, payments toward an employee’s qualified educational loans can be part of a total compensation package and excluded from a worker’s taxable income, lowering their gross wages and resulting in tax advantages for your client.

Contributions made above the monetary limit are generally considered taxable wages subject to all employment taxes. Also, the maximum amount includes either education-related expenses, student loan payments or a combination of both.

5. Qualified transportation and parking expenses

Your client’s household employee can set aside $280 in pre-tax dollars each month for transportation expenses and that same amount for parking expenses. This reduces their gross income and lowers both their and your client’s tax obligations.

Transportation expenses include public mass transit (subway, train, busses, ferries, etc.) passes, tokens, fare cards and vouchers as well as vanpooling. Tolls and gas are not qualified expenses. Parking expenses include fees incurred when parking at or near your client’s home and parking at or near a location from where the employee commutes via mass transit or commuter highway vehicle. Qualified bicycle commuting reimbursements are no longer eligible as a tax-free benefit. However, your client can provide the bicycle benefit as a taxable benefit.

What This Means for Legal Pay

The burden of paying nanny taxes should never be used as an excuse for hiring a household employee “under the table.” While legal pay is always the right thing to do to avoid trouble with the IRS and state tax and labor agencies, families can easily reduce – and even eliminate – their employer tax responsibility through pre-tax benefits, tax credits and/or their Dependent Care FSA.

* These are also sample calculations based on state and federal tax rates, typical pay ranges and allowances and should not be regarded as formal tax advice. Your client’s individual results may differ.

Replies (0)

Please login or register to join the discussion.

There are currently no replies, be the first to post a reply.