Utilizing a Dependent Care Account and/or the child care tax credit will lower your child care costs.
Are you one of the thousands of New York families that hired a summer nanny for your child care needs this year? Given the current COVID-19 landscape, it’s possible you’ve hired in-home child care for the first time because your normal summer programs are not available. The good news is a summer nanny can be much less expensive than you think when you pay the nanny legally due to the way tax and payroll laws work out. Here’s how it works:
When you hire a nanny on a short-term basis, your employer taxes are calculated based on the wages paid to the nanny. Since you’re only employing your summer nanny for two or three months, those wages are relatively low, so your tax obligation as a household employer won’t be very large. But on the same hand, you’ll be able to apply most, if not all, of your nanny’s wages to a Dependent Care Account and/or the child care tax credit. This can result in a tax savings that is more than the taxes you owe!
An Example of a Summer Nanny Budget with Tax Breaks
| Gross wages paid to the nanny | $7,200 |
| Social Security taxes | + $446 |
| Medicare taxes | + $104 |
| Unemployment Insurance taxes | + $267 |
| Total employment taxes | $817 |
| Total cost to the family (before tax breaks) | $8,017 |
Since the family pays their nanny on the books, the parents qualify for tax breaks because each parent works and both children are younger than 13. Plus, if the family is enrolled in a Dependent Care Account (a type of Flexible Spending Account, or FSA) through their employer, they will be allowed to pay for $5,000 of child care expenses tax-free.
| Cost before tax breaks | $8,017 |
| Savings from FSA | – $2,000 (based on the family’s tax bracket*) |
| Total cost of summer nanny | $6,017 |
*This estimated savings is due to the fact that the family is using money from the FSA, which is deducted from paychecks before taxes are taken out, so the family is paying less in taxes overall.
As you can see, the family is now saving $1,183 (the difference between the gross wages paid to the nanny and the final cost after FSA savings are applied) by paying their summer nanny on the books!
It’s important to note that the Internal Revenue Service considers the current COVID-19 landscape to be a life-changing event (so is a change in child care needs). That means you can enroll in a Dependent Care Account now because you’ve hired a summer nanny. To have this set up as soon as possible, have a conversation with your HR Department to enroll.
What if the family doesn’t have access to an FSA?
The family can still use the child care tax credit (IRS Form 2441) to save 20 percent on up to $6,000 of their child care expenses, i.e. their summer nanny’s wages.
| Cost before tax breaks | $8,017 |
| Savings from child care tax credit | – $1,200 |
| Total cost of summer nanny | $6,817 |
In this scenario, the family still saves $383 (the difference between the gross wages paid to the nanny and the total cost after tax breaks) by paying their summer nanny on the books. If they paid under the table, the family would not be eligible for either of these two tax breaks.
If you would like to run a payroll and budget scenario that is specific to your current summer nanny needs, HomePay has a Nanny Tax Calculator available that takes into account the tax breaks families who hire a summer nanny are entitled to. You may be surprised with the results you see!
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