Though most families want to consider their nanny an “independent contractor” to avoid costly payroll taxes and the associated administrative duties, nannies are household employees. The instructions for Form 1040, Schedule H are pretty clear on this matter.

One of the most important decisions working parents will make is deciding who will get the honor of taking care of their little one during the day. My husband and I decided to hire a nanny to watch our sweet little boy, Henry. We liked the idea of Henry getting excellent one-on-one care from an experienced caregiver, and daycare can present challenges for us in terms of picking up and dropping off our son each day – we may be parents, but our career demands still exist. Hiring a nanny worked well for our situation, but there are certainly administrative and tax responsibilities to consider when making this decision:

All employers are responsible for payroll taxes. A household employer will need to obtain an Employer Identification Number, withhold taxes from their nanny’s paycheck, and remit those taxes, in addition to their share of taxes, to government agencies. The employer’s share of taxes includes 7.65 percent for Social Security and Medicare taxes (aka FICA taxes), as well as contributions for State Unemployment Insurance (SUI) (amount varies by state) and the Federal Unemployment Tax Act (FUTA), which is 6 percent, reduced by a credit for contributions paid to a state.

Often, this means making estimated tax payments for federal purposes (using quarterly payment vouchers) and making quarterly state deposits. The employer will also need to provide a Form W-2 to the nanny every January. Then, come April 15, the employer will need to file Form 1040, Schedule H (assuming the household employee was paid $1,900 or more during the year, or $1,000 or more in any calendar quarter).

Employers need to consider benefits

Household employers are not required to provide health care insurance for their household worker (i.e., there are no major ACA consequences). However, health insurance is often an important component of the household employee’s benefits package, and families need to consider insurance and other benefits, such as vacation time, sick time, bonuses, etc.

4 Tips to Make this a Hassle-Free Option

Overwhelmed and ready to send your child to a daycare to avoid all of this? Understandable. However, I’ve been able to make the process fairly seamless by following these steps:

First, find the “perfect” nanny. I found a great nanny by using care.com. I purchased a subscription for one month (about $30), posted a job, and was able to find an amazing nanny. I originally planned to hire someone from a nanny agency to avoid various administrative burdens, but I quickly learned that either the agency didn’t actually manage payroll and taxes correctly or the nanny selection was grossly limited as compared to the selection on care.com.

I found a great nanny by using care.com. I purchased a subscription for one month (about $30), posted a job, and was able to find an amazing nanny. I originally planned to hire someone from a nanny agency to avoid various administrative burdens, but I quickly learned that either the agency didn’t actually manage payroll and taxes correctly or the nanny selection was grossly limited as compared to the selection on care.com. Use an inexpensive payroll service to manage the administrative burdens. I use HomePay, which helps me tremendously, but there are several payroll providers to choose from. Each week a simple tool calculates the check amount for my nanny based on the hours she worked (factoring in payroll tax withholdings). I can then print a paystub or have one automatically emailed to her. I could choose to pay our nanny via direct debit and decrease the paperwork further, but she opted to be paid via check.

HomePay also allows me to pay all payroll taxes via direct debit so that I really don’t have to think about them. Finally, HomePay prepares the Schedule H, Form W-2, and any other payroll tax forms for me. Plus, the one time I needed to call HomePay with a question, I talked to a real person immediately.

Take advantage of the dependent care flexible spending account. I defer the maximum ($5,000) to my employer’s plan. I then submit for reimbursement quarterly. The tax benefits of this plan pays for about a month of childcare.

I defer the maximum ($5,000) to my employer’s plan. I then submit for reimbursement quarterly. The tax benefits of this plan pays for about a month of childcare. Let your nanny help you with other household chores. When Henry naps, our nanny is able to help us with various household tasks, such as laundry and cleaning. Working and being a parent can be hard to balance, especially with sleepless nights with a young baby. Any help we can get with day-to-day activities is much appreciated.

On a personal note, having a nanny, though often more expensive and requiring more administrative effort than traditional daycare, is the best decision we’ve ever made. Our nanny is a trusted friend and we value her like a family member.

Susan C. Allen CPA, CITP, CGMA, Lead Technical Manager - Taxation, American Institute of CPAs.

Photo courtesy of Susan Allen.