The Nanny Tax. How Does it Work?

For many families, the end of the school year means hiring a nanny. As an employer (yes, the IRS considers you an employer), you are now responsible for withholding and paying certain taxes on behalf of your employee. No pressure, right?

Who Exactly Are We Talking About?

When an individual works in someone's home and has specific tasks and responsibilities dictated by the homeowner, the IRS considers that individual a household employee. This designation covers a wide range of roles, including, but not limited to, nannies/babysitters, health aides, caretakers, house cleaners, and yard workers.

When the definition of household employee is met, and the family/employer pays the employee more than $2,800 in 2025 ($2,700 in 2024), the employer should be withholding and paying Social Security and Medicare taxes on behalf of the employee.

What about family members? If an older sibling is under age 21 and watching their younger siblings, employment taxes won't apply. The same goes for grandparents. The last exception is for an "employee" who is 18 or younger at any time during the calendar year and is also a student or has other employment, and nannying is not their primary occupation.

What Taxes Are We Talking About?

Employers are required to collect and pay Social Security and Medicare tax, also known as FICA. This mandate applies to traditional corporate employers and families who meet the definition of an employer. The employer's portion of FICA taxes is 6.2% for Social Security and 1.45% for Medicare taxes, for a total of 7.65%.

The employee must also pay their share, which is another 7.65%. Generally, the employee portion should be withheld from their pay. If the employer fails to withhold the employee portion from their wages, the employer is responsible for the entire 15.3%. Some employers may offer to cover the full amount of the tax, but that will vary from family to family. The employee can also elect to have federal and state taxes withheld, but that is not mandatory.

If the employer pays more than $1,000 in any quarter of the calendar year, the employer is also responsible for paying a 6% Federal Unemployment Tax (FUTA) on the first $7,000 in wages. Each state has laws determining whether state unemployment insurance or disability and workers' compensation are also required. If state unemployment taxes apply, the FUTA tax rate can be reduced to .6%.

Who Creates the Tax Forms?

The first step is for the family/employer to apply for an employer identification number (EIN). This may sound intimidating, but it can be done in less than 10 minutes at www.irs.gov.

Many families purchase software designed specifically to pay household employees along with generating the appropriate tax forms, reporting withholding, and any other required information. Another option is to hire a bookkeeper or an accountant to help with filings and to ensure everyone is compliant.

The aforementioned takes care of the employee's required tax filings. What about the employer's required filings? Employers need to file a Schedule H when completing their individual 1040. This form covers FICA taxes, FUTA taxes, and other taxes that might have been withheld. Most families also make quarterly tax payments.

Can The Family/Employer Offset Their Tax Liabilities?

Depending on their situation, families may have a few options to reduce their tax bill. Some employers offer a Dependent Care Flexible Spending Account (FSA) as part of their benefit offerings. Employees can contribute up to $5,000 of their pretax earnings to the account for qualified dependent care expenses. Don't get overzealous; any funds remaining in the account at the end of the year are lost, so contributions should mirror anticipated expenses.

Another possible tax benefit is the Child and Dependent Care Credit. This credit lets you claim between 20% and 35% of your childcare expenses based on your income. The credit can be up to $3,000 for one child or $6,000 for two or more children. It's possible that a family can utilize a Dependent Care FSA and the Child and Dependent Care Credit, but not for the same expenses.

Cash Isn't Always King

It's not uncommon for families to pay their childcare providers in cash, but several legal requirements must be adhered to, as outlined above.

Paying a nanny under the table puts the employer and the employee at risk. If the IRS gets involved, penalties and back taxes will almost certainly be applied. A nanny could also file for unemployment if their work with a family ends (even if everyone is on good terms). That claim will trigger the state unemployment office that the applicable taxes were not paid.

Beyond providing peace of mind, paying a nanny legally also helps them build credits with Social Security and Medicare that may benefit them down the road. Bottom line, it's worth taking the time to structure household employee arrangements at the beginning of an engagement so everyone involved is protected from day one.

About Us | Get the Bedel Blog | More Tax Planning Articles