What is the “nanny tax”?
The phrase “nanny tax” refers to the payroll taxes that household employers must pay when they hire a household employee (for example, a nanny, full‑time babysitter, live‑in caregiver, housekeeper, cook, or butler) and pay that person cash wages above certain federal thresholds. The taxes include Social Security and Medicare (FICA) taxes and federal unemployment tax (FUTA); state employment and unemployment rules may also apply. The IRS treats ongoing household workers as employees—not independent contractors—so the family becomes an employer for tax purposes. (See IRS Publication 926; IRS Topic No. 756.) [Sources: Investopedia; IRS Pub. 926; IRS Topic No. 756]
Why it matters
– Keeps the worker covered by Social Security, Medicare and unemployment insurance.
– Gives the employee verifiable earnings history for loans, Social Security credits, etc.
– Allows employers to use child/dependent care tax benefits (subject to rules) and may enable use of dependent-care FSAs.
– Avoids penalties for misclassification or unpaid employment taxes.
Who is a household employee?
A household employee is a person you hire to do household work—and you control how the work is done. Typical examples: nannies, regular babysitters (who work on an ongoing basis), housekeepers, private nurses, gardeners who work under your direction. The IRS tests whether the person is an employee (you control the work) vs. an independent contractor (worker controls how the work is done). Some exceptions apply: a parent or spouse working for you is generally not treated as a household employee; minors under a certain age who aren’t principally engaged in household employment may also be excluded. (See IRS guidance on employee vs. contractor and Pub. 926.) [Sources: Investopedia; IRS Pub. 926]
Federal thresholds and rates (examples and note on updates)
– Social Security and Medicare (FICA): The IRS sets a threshold of cash wages paid per calendar year above which Social Security and Medicare taxes apply for household employers. For example, in 2021 that threshold was $2,300 in cash wages per employee for the year; after that point, FICA applies. When FICA applies, the combined tax rate is 15.3% of wages (12.4% Social Security + 2.9% Medicare). That burden is typically split: the employee’s share (withheld from wages) is 7.65% and the employer pays 7.65%; some employers elect to pay the entire 15.3% themselves. (Rates and thresholds change from year to year—always check current IRS figures.) [Sources: Investopedia; IRS Pub. 926]
– Federal Unemployment Tax (FUTA): If you pay cash wages of $1,000 or more in any calendar quarter to household employees, you generally owe FUTA. The FUTA tax rate on the first $7,000 of wages historically has been 6.0% before credits; the effective rate is often lower because employers receive credits for state unemployment taxes. (Check current-year rules.) [Sources: Investopedia; IRS Pub. 926]
– State taxes: States may have their own unemployment, disability, and withholding rules for household employers. Always confirm state requirements. [Source: IRS Pub. 926]
Common exemptions and special cases
– Paid through an employment agency: If you hire a worker through a household employment agency that pays the worker, the agency is generally the employer and responsible for taxes.
– Family members: Payments to a spouse are generally not subject to nanny tax; special rules apply to parents paying their children—check IRS guidance.
– Short-term or infrequent babysitters: Occasional babysitters who aren’t regular employees may not trigger household-employer status. But “regular” weekend sitters or a weekend nanny can cross the threshold (example: $50 per weekend x 52 = $2,600 triggers FICA in the 2021 example). [Sources: Investopedia; IRS Pub. 926]
Practical step‑by‑step guide for household employers
1) Determine worker classification
– Ask: Do you control both what work is done and how it is done? If yes, the worker is likely an employee. Use IRS guidance on employee vs. contractor. Document your determination.
2) Track wages carefully
– Record all cash and noncash wages paid, dates, and hours. Keep receipts, time records, checks, or bank transfers. This establishes whether thresholds are met.
3) Check current thresholds and rates
– Verify the current-year FICA thresholds, FUTA threshold, and tax rates on the IRS website (Pub. 926 and Topic No. 756). Thresholds and rates change annually.
4) Get an Employer Identification Number (EIN) if required
– If you will pay employment taxes, obtain an EIN from the IRS (you’ll need it to file certain forms and to prepare W‑2s). [IRS Pub. 926]
5) Decide whether to withhold income tax
– You’re not required to withhold federal income tax for a household employee unless the employee requests withholding and they complete Form W‑4. If you withhold income tax, you must follow withholding deposit rules and filing requirements.
6) Calculate and collect FICA
– If yearly wages exceed the Social Security/Medicare threshold, withhold the employee’s share (7.65% in the 2021 example) from each paycheck and pay the employer share. Keep records of withheld amounts and employer contributions.
7) Handle FUTA
– If you paid $1,000 or more in any quarter to household employees in a year (example threshold), you generally owe FUTA on the first $7,000 of each employee’s wages. File Form 940 as required. (See current rules for deposits and credits against FUTA.) [Source: IRS Pub. 926]
8) Report and pay taxes on time
– Household employment taxes (Social Security, Medicare, withheld income tax) are reported on Schedule H (Household Employment Taxes) of your Form 1040 and typically paid when you file your personal income tax return. FUTA is reported on Form 940 and may have separate deposit requirements. If you withhold federal income tax or are required to deposit withheld taxes, follow IRS deposit schedules and filing (Form 941 or 944 rules may apply in limited situations). Consult Pub. 926 for exact filing instructions. [Source: IRS Pub. 926]
9) Provide forms to the employee and government
– By January 31 following the tax year, furnish the employee with a Form W‑2 showing wages and withheld taxes. File Copy A of Form W‑2 with the Social Security Administration (and W‑3 if required) by the deadline. If you paid household employees and report on Schedule H, you still must issue W‑2s and file W‑2/W‑3 with SSA. [Source: IRS Pub. 926]
10) Keep records for at least four years
– Maintain employment records (wage statements, Forms W‑2/W‑3, time sheets, Form 940 / 941 returns, deposit records) in case of audit.
11) Consider payroll help
– Many families use household payroll services (or a CPA/bookkeeper) to calculate taxes, make tax deposits, prepare W‑2s, file forms, and issue payments. These services can reduce errors and penalty risk.
Examples (illustrative; always confirm current-year numbers)
– Example 1: Weekend babysitter paid $50 each weekend = $50 x 52 = $2,600/year. In the 2021 rule-of-thumb, that exceeds the $2,300 threshold, so FICA taxes apply; you would withhold the employee share and pay the employer share of Social Security and Medicare. (Also consider FUTA threshold if you pay $1,000+ in any quarter.) [Source: Investopedia example]
– Example 2: You pay a household employee $8,000 in a year. You may owe Social Security and Medicare on the wages (subject to yearly thresholds) and FUTA on the first $7,000 of wages (subject to credits for state unemployment taxes).
Benefits to the household employee and employer
– Employee: Social Security credits, Medicare coverage, unemployment benefits (if eligible), verifiable income for credit checks.
– Employer: Access to tax benefits like the Child and Dependent Care Credit for eligible childcare expenses, and possible pre-tax benefits through dependent-care FSAs (rules apply). Proper compliance avoids penalties and legal risk. [Sources: Investopedia; IRS Topic No. 602; IRS Pub. 926]
Penalties and risks of noncompliance
– Failure to report and pay employment taxes can result in penalties, interest, and liability for unpaid taxes. Misclassifying a household employee as an independent contractor can trigger significant back taxes and penalties. The IRS pursues enforcement for unpaid employment taxes. [Source: IRS enforcement guidance; Investopedia]
Checklist for first‑time household employers
– Classify the worker (employee vs. contractor) and document the decision.
– Track all wages and determine whether thresholds are met.
– Obtain an EIN if necessary.
– Have the worker complete Form W‑4 if you will withhold income tax.
– Withhold and deposit FICA if threshold met; pay employer share.
– File Form 940 and pay FUTA if required.
– Issue Form W‑2 to the worker by Jan. 31 and file W‑2/W‑3 with SSA.
– Report household employment taxes on Schedule H (Form 1040) or follow required deposit/filer rules if withholding income tax.
– Keep complete records and consider a payroll service or tax professional.
Where to get authoritative, current information
– IRS Publication 926, “Household Employer’s Tax Guide” (primary guide for household employers).
– IRS Topic No. 756, “Employment Taxes for Household Employees.”
– IRS Topic No. 602, “Child and Dependent Care Credit.”
– Consult your state’s department of labor or revenue for state-level rules.
(Links: IRS Pub. 926 and Topic No. 756; see Investopedia summary for a plain‑language overview.) [Sources: IRS Pub. 926; IRS Topic No. 756; Investopedia summary]
Final recommendations
– Don’t assume a household worker is an independent contractor just because you pay cash.
– Check current IRS thresholds and state rules every year before making decisions.
– Use a payroll service or qualified tax professional if you are unsure—this frequently costs less than penalties for mistakes and saves time.
Sources
– Investopedia, “Nanny Tax” (source article provided).
– Internal Revenue Service, Publication 926, “Household Employer’s Tax Guide.”
– Internal Revenue Service, Topic No. 756, “Employment Taxes for Household Employees.”
– Internal Revenue Service, Topic No. 602, “Child and Dependent Care Credit.”
If you’d like, I can:
– Walk through a sample calculation for your specific pay schedule and current-year rates; or
– Provide a one‑page printable checklist of forms and dates you’ll need. Which would help most?