Are You Liable for “Nanny Taxes”?
JACQUELINE JANCZEWSKI, CPA, MBT
If you employ household workers — which may include nannies, babysitters, housekeepers, cooks, gardeners, health care workers and other employees — it is important to understand your tax obligations, commonly referred to as “nanny taxes.” Here is a quick review.
Related Read: Your Responsibility When Hiring Household Help
Which workers are covered?
Simply working in your home does not necessarily make a worker a household employee. You are not required to withhold or pay taxes for independent contractors — such as occasional babysitters who work for many different families.
But the rules for distinguishing between employees (who trigger nanny tax obligations) and independent contractors (who do not) are complicated, so be sure to consult with your ORBA tax advisor if you are uncertain.
Which taxes must you pay?
Your nanny tax obligations vary depending on the type of tax:
You are not required to withhold federal income taxes (or, usually, state income taxes) from a household employee’s pay, unless the employee asks you to and you agree. In that case, you will need to have the employee complete Form W-4 and you will need to withhold income taxes on both cash and noncash wages (other than certain meals and lodging).
You must withhold and pay FICA taxes (Social Security and Medicare) if your household employee’s cash wages reach a specified threshold ($2,300 for 2021). If you meet the threshold, you must pay the employer’s share of Social Security taxes (6.2%) and Medicare taxes (1.45%) on the employee’s cash wages (but not on meals, lodging or other noncash wages). In addition, you are responsible for withholding the employee’s share of these taxes (also 6.2% and 1.45%, respectively), although you may opt to pay the employee’s share rather than withholding it.
Note: There is no FICA tax liability for wages that you pay to certain family members or household employees under the age of 18 if working for you is not their principal occupation. A student who babysits on the side would be one example.
You must pay federal unemployment tax (FUTA) if you pay total cash wages to household employees (other than certain family members) of $1,000 or more in any quarter in the current or preceding calendar year. The tax applies to the first $7,000 of an employee’s cash wages at a 6% rate, although credits reduce that rate to 0.6% in most cases.
How are taxes reported and paid?
Unlike businesses, you generally do not need to file quarterly employment tax returns for household employees. Rather, you report household employment taxes on Schedule H of your income tax return. However, if you own a business as a sole proprietor, you may add the taxes for household employees to the deposits or payments you make for your business employees and include household employees on Forms 940 and 941.
Even if you report household employment taxes on Schedule H, you are still responsible for paying the tax throughout the year, either through quarterly estimated tax payments or by increasing withholdings from your wages. Otherwise, you will have to pay the tax when you file your return and be subjected to penalties for underpayment of estimated tax.
You will also need to file Form W-2 if you are required to withhold FICA taxes or agree to withhold income taxes for a household employee.
Know your obligations as an employer
In addition to the tax requirements discussed above, there may be other obligations that come with being an employer. These may include complying with minimum wage and overtime requirements and documenting immigration status. Turn to your ORBA tax advisor for more information.
Retire Happily Ever After, Tax-Wise
LARRY A. RUFF, CPA, MBA
“Each of us has a dream, a heart’s desire. It calls to us. And when we are brave enough to listen and bold enough to pursue, that dream will lead us on a journey to discover who we are meant to be” and to retire happily ever after. “All we have to do is look inside our hearts and unlock the magic within…”
That tidbit, from Disney’s “Happily Ever After,” with the add-on about retirement is the dream that we would all like to achieve, but this requires some financial and tax planning on your part.
Retiring changes practically everything from cash flow, living expenses, taxes to much more. Questions abound about how to manage your income, start Social Security, handle your retirement benefits and minimize taxes in retirement. And, there are other important considerations like Medicare and where you would live in retirement. Keep in mind that the goal, to retire happily ever after, includes tax planning, which is where this article takes you on this magical journey.
If you are retired or approaching retirement, consider the following tax-planning ideas.
Related Read: Three Tips for Making Retirement Less Taxing
Start your journey by estimating how much money you will spend annually in retirement for living expenses, including healthcare costs, travel and taxes. Consider that you will be spending money on occasional big-ticket items, such as automobiles and household improvements. You cannot always plan those items, but make sure you have enough cash assets to cover those costs. The purpose of this exercise is to give you an idea of how much cash will be required to sustain your cost of living.
With that as a starting point, next inventory your cash and income sources to pay those expenses. Do this by adding up your taxable, tax-deferred and nontaxable assets into separate buckets for both federal and state income tax purposes. Taxable sources may include mutual funds and brokerage accounts; tax-deferred assets could include traditional IRAs, 401(k) plan accounts and pensions; and nontaxable assets would be Roth IRAs, Roth 401(k) plans or tax-exempt municipal bonds. Social Security benefits may be nontaxable or partially taxable, depending on your other sources of income.
Manage your tax buckets
Develop a plan for drawing retirement income in a tax-efficient manner, while keeping state income tax, if applicable, in mind. Consider an action plan that involves each of your tax buckets. In preparation for retirement, you might consider shifting the assets and the associated income around in your buckets as much as possible to gain tax efficiency.
For example, look at how you might minimize ordinary income on your taxable assets by building taxable assets that generate tax-favored statuses like qualified dividends and long-term capital gains. Building significant cash in your taxable bucket helps to pay for your living expenses and minimize your taxable income. Consider adding some tax-exempt interest to your taxable assets.
You can begin receiving Social Security benefits as early as age 62 or as late as age 70. The later you start, the larger the benefit grows. For most taxpayers, Social Security benefits will be largely taxable (up to 85%), which means the longer you delay benefits, it helps reduce your taxable income potentially up to age 70.
You might manage your tax-deferred assets by annually doing partial conversions to a Roth IRA from your pre-tax 401(k) or traditional IRA balances. Convert enough tax-deferred assets to fill up your current tax bracket. Keep in mind the net investment income tax when doing this. Although conversions are not part of that additional tax, they do go into your adjusted gross income when making the determination.
If you delay signing up for Social Security benefits to age 70 and need cash for living expenses, it may make sense to withdraw some of your tax-deferred IRA funds earlier. It can help provide cash and avoid having large required minimum distributions (RMDs) that would push you into a higher tax bracket later.
If you are charitably inclined, you can use your tax-deferred assets to make a qualified charitable distribution (QCD) starting at age 70½. A QCD allows you to distribute up to $100,000 directly from a traditional IRA to a qualified charity. The funds are not included in your income. However, they are excluded from being treated as a charitable deduction.
These assets are mainly built through Roth IRA balances. As mentioned above, multiple partial Roth conversions are the quickest way to build these assets. Other ways to build these assets include pre-retirement contributions to a Roth 401(k) plan and Roth IRA.
With sizable nontaxable Roth assets, you can use them to balance out your taxable income in retirement by partially withdrawing them to support your living expenses or for sizeable purchases.
Building and holding nontaxable assets also help alleviate large tax bills for the beneficiaries of your estate. In 2019, the SECURE Act changed the way estate assets may be inherited and spent over a non-spouse or non-qualified beneficiary’s lifetime.
Instead of having the ability to withdraw inherited retirement plans and IRA assets over the life expectancy of the non-spouse beneficiary, these assets now must be withdrawn over ten years. Large tax-deferred retirement plans and traditional IRA balances will become subject to taxation much sooner with this change and could cause very large tax bills.
Let’s get started
Developing a tax-efficient plan for retirement and putting it into place takes years to complete. Once you have your plan in place, it should be reviewed annually to make sure it is on target because situations and tax laws change. Keep in mind that these are suggestions and what works for one individual or couple may not work for another with different goals.
A thoughtful retirement tax plan will help you better enjoy your retirement where you can live your dream and retire happily ever after tax-wise. If you are nearing or at retirement age talk to your ORBA tax advisor to develop a plan and assist you with keeping it on track. And, with a tax-efficient plan in place, maybe you can even afford to take your grandchildren to Disney World.