What you Need to Know Before Hiring a Nanny
/With schools and daycares closed or in limited operation due to covid-19, many are considering hiring a nanny to help with childcare and schooling. Unlike enrolling your child in a daycare center or summer camp, hiring a nanny opens up a Pandora’s box of legal and tax obligations. Here is a summary of what you need to know.
Determine if you have an employee.
If you control when and how a service is performed, the person working for you is an employee.
An example of this is hiring a nanny to watch your children in your home. If you set the hours, provide the supplies, and give specific instructions in relation to the nanny’s responsibilities, an employee / employer relationship exists. You are the employer and they are the employee.
When you do not have control over how someone performs the service, there is no employee / employer relationship. An example of this would be a home daycare that uses their own supplies and offers their services to the public.
The drawbacks of paying cash.
Many parents prefer to pay a nanny in cash “under the table” to avoid the time consuming and stringent requirements associated with establishing an employee / employer relationship. Nannies tend to also prefer being paid this way to avoid paying taxes on their income. Before going down this path, here are some things to consider.
The penalty for non-compliance is severe.
Employers are required to pay employment tax if their employee earns $2,200 or more in wages (for 2020). Employment tax, also known as payroll tax, consists of social security tax (6.2% up to $137,700 in 2020) and Medicare tax (1.45% on all wages). Both the employer and the employee pay that amount, so the total tax being paid is 15.3%. If the IRS determines that you had a household employee that you should have been classifying as such, you will owe the taxes due plus interest and penalties.
The nanny’s income will not count towards their social security benefit.
Social security income, which is essentially an inflation-adjusted pension, is a great benefit. The amount of social security income you receive depends on how much you made when you are working. If your nanny is being paid under the table, he or she will not get credit for those wages and their future social security income may be lower than if the wages have been documented.
The nanny will not be able to claim unemployment insurance.
Covid-19 showed how quickly household employees can be dropped. When most people lose their job, they receive unemployment income because their employer paid FUTA, which stands for the Federal Unemployment Tax Act. Some states also require the employer to pay unemployment insurance premiums. If employees are paid cash and it is not reported, they will not be able to claim any unemployment benefits since they haven’t paid into the system and there is no proof of earnings.
How to correctly hire a nanny.
If you have decided to hire a household employee (such as a nanny, but this information also applies to a house cleaner or pet sitter), and aren’t sure how to get started, here is a checklist.
Protect yourself with worker’s compensation insurance.
If your employee gets injured in your home during working hours, you can be held responsible. Even if you have adequate liability coverage on your homeowner’s policy or a separate umbrella policy, that does not cover you for employees. You need to purchase a separate workers compensation policy.
Work with a tax preparer to help you file the necessary paperwork.
File for an EIN number.
The Employer Identification Number (EIN) is how the IRS identifies your employee / employer relationship.
Register with your state’s Department of Labor.
Have the employee complete a Form I-9.
You do not need to file this form anywhere but you are required to keep it on file in case it is requested by a U.S. government official.
Register the new employee with your state’s tax department, if applicable.
Have the employee complete a W-4.
This is the employee’s opportunity to document if and how much tax they want withheld from the paycheck you will be issuing them.
Set up a payroll system, such as QuickBooks Online. This will allow you to:
Pay your employee every pay period.
Generate a W2 at tax time - a copy will be furnished to the employee, the IRS, and the Social Security Administration.
Withhold the necessary payroll taxes, unemployment insurance, federal, and state taxes based on the W-4 form the employee completed.
File the required quarterly reports with your state, which shows how much you paid the employee and how much was paid towards state unemployment insurance, if applicable.
File Schedule H with your tax return at tax time.
If hiring a nanny is the best choice for you, don’t let the logistics scare you.
Setting yourself up to hire a household employee can certainly be time consuming. That is why, in normal times, many people choose a daycare or house cleaning company to prevent having to deal with the payroll, insurance, and reporting requirements. But given this challenging time, hiring a nanny may be the best option for you and your family. If that is the case, now you know how to do it properly. Reach out to our Virtual Financial Advisors with any questions specific to your situation.
Linda Rogers, CFP®, EA, MSBA is the owner and founder of Planning Within Reach, LLC (PWR). Originally from New Jersey, Linda services clients throughout San Diego county and nationwide. She leads the design of PWR's investment portfolios which utilize broad, low-cost investments that integrate environmentally, socially, and governance (ESG) factors.
Planning Within Reach, LLC (PWR) is a fee-only and fiduciary wealth management firm offering one-time comprehensive financial planning, ongoing impact-focused investment management and tax preparation services in San Diego and nationwide. PWR is a woman-owned firm that specializes in busy professionals and impact investors. Planning Within Reach, LLC and their advisors do not receive commissions and do not hold any insurance licenses or brokerage relationships.