Sorting out nanny tax rules

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Dear Tax Talk,
My wife and I both work and we have a 4-year-old son. We hire my parent to take care of our son and pay her a total of $5,000/year. Are we required to pay employment taxes on the wages and issue her a W-2?

If we are not required to pay employment taxes on the wages, can my parent still file her income tax return and receive her work credit? Thank you very much for your response.
— Bao


Dear Bao,
IRS Publication 926 discusses employment taxes for household employees. For many years, household employment slid under the radar of taxes, until some presidential nominees got into hot water for hiring illegal nannies. Now the IRS makes it somewhat simpler to comply with your obligations for taxes on household help.

Principally, the IRS is looking to collect Social Security and Medicare taxes on wages paid to your household help. The rate is 7.65 percent for the employer, and you must withhold 7.65 percent from payments to the employee (for a total of 15.3 percent). If you choose, you can pay the 7.65 percent that is supposed to be withheld from the employee, but you would count this as additional wages to the employee when you issue her a Form W-2 at the end of the year.

For example, if you pay $100 to your employee, you would pay $7.65 in payroll taxes and would need to collect $7.65 from your employee. Since your employee may not appreciate receiving $92.35, you may go ahead and pay him or her $100. At the end of the year, you owe the IRS with your Form 1040 $15.30 for payroll taxes, and you would give your employee a W-2 for $107.65. Of course, there are thresholds. You don’t have to file and pay on wages that are less than $1,500 in a year.

You also owe federal unemployment tax, but that’s only $8 for every $1,000 in wages. You might also owe state income and employment taxes, depending on the state in which you live.

Cash wages paid to a parent for in-home services are generally not considered wages for purposes of household employment taxes. However, you count these wages if both of the following conditions apply.

Household employment tax rules:
a. Your parent cares for your child who is either of the following.
i. Under the age of 18.
ii. Has a physical or mental condition that requires the personal care of an adult for at least four continuous weeks in a calendar quarter.
b. Your marital status is one of the following.
i. You are divorced and have not remarried.
ii. You are a widow or widower.
iii. You are living with a spouse whose physical or mental condition prevents him or her from caring for your child for at least four continuous weeks in a calendar quarter.

Since you are married, you would not provide your mother with a Form W-2. Since she does not have wages, she would not qualify for the earned income credit.

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