We have documented the different nanny taxes you will owe and how much you may pay when you employ someone to work in your home. Now the good news! Here are five ways to reduce your nanny taxes that can save both you and your employee money.
1. Dependent Care Flexible Spending Account (FSA)
A Dependent Care FSA – offered through your employer – sets aside pretax money from your paycheck to help pay qualified, out-of-pocket childcare costs like your nanny’s wages. You can contribute up to $5,000 as an individual or as a married couple filing jointly, or $2,500 for a married person filing separately. That means, for a married couple, each parent can contribute $2,500 to their own Dependent Care FSA. Since these contributions are made pre-tax, they reduce your taxable income. Depending on your tax bracket, you can save a few thousand dollars by using a Dependent Care FSA when employing a nanny.
2. Child and Dependent Care Tax Credit
The wages you pay your nanny are a qualified expense for the Child and Dependent Care Tax Credit. To take advantage of this credit, attach Form 2441 with your personal tax return. For the 2022 tax year (returns filed in 2023), the Child and Dependent Care Tax Credit returns to $3,000 in expenses for a family with one child and $6,000 for families with two or more children. You can typically take 20 percent of your expenses as a credit. That means $600 for one child or $1,2000 for two or more children.
You can not use the same expense for both a Dependent Care FSA and the Child and Dependent Care Tax Credit. If you have $5,000 in childcare expenses and are reimbursed through a Dependent Care FSA, you would not be able to claim the Child and Dependent Care Tax Credit.
However, if you have childcare costs left over after maxing out your Dependent Care FSA, you can claim those expenses with the tax credit. For example, if you paid a nanny $11,000 or more and have at least two kids, you can be reimbursed $5,000 through your Dependent Care FSA and then claim $6,000 with the Child and Dependent Care Tax Credit.
3. Qualified Small Business Health Reimbursement Arrangement (QSEHRA)
It is true that by offering health benefits to your nanny that you can reduce your nanny taxes.
A QSEHRA reimburses your nanny for health insurance coverage purchased on the individual market or through the health care exchange and/or for out-of-pocket medical, dental, and vision expenses.
You can fund the QSEHRA up to $5,850 for a nanny who is single and $11,800 per employee with a family (2023 contribution rates). Those contributions are not taxed for you or your employee. Reimbursements for your nanny are also not taxed.
Here is how you can save:
Let’s say you are in New York State and plan to hire a nanny at $20/hour for 40 hours/week without pre-tax health benefits.
Using our nanny tax calculator, we can determine*:
|Federal income tax||$3,232.32|
|State income tax||$1,670.24|
|Net (take-home) pay||$33,515.04|
|Total employer responsibility||$45,271.30|
Let’s take the same scenario but instead you reduce your employee’s gross pay by $5,850, which is the maximum contribution you can make to their QSEHRA account.
|Gross pay||$35,750 ($17.19/hour)|
|Federal income tax||$2,408.64|
|State income tax||$1,395.16|
|Net (take-home pay)||$29,211|
|Employer health benefit contribution||$5,850|
|Total take-home compensation||$35,061|
|Total employer responsibility||$44,824.10|
In this scenario, a household employer saves about $450 by offering a QSEHRA as part of a total compensation package.
Remember a nanny’s hourly pay still must be about the applicable minimum wage rate even if you reduce their total compensation by your QSEHRA contributions.
*These are sample calculations based on state and federal tax rates, typical pay ranges, and allowances and should not be regarded as formal tax advice. Your individual results may differ. Consult a tax professional for specific advice and guidance or call us at (800) 929-9213.
4. Individual Coverage Health Reimbursement Arrangement (ICHRA)
ICHRAs are like QSEHRAs as they are both employer-funded health reimbursement arrangements (HRAs) that reimburse employees tax-free for health insurance premiums and/or medical expenses. The money contributed by a family to an ICHRA is also not subject to employer taxes.
The major difference between the two options is that there are no annual contribution limits with an ICHRA while QSEHRAs are restricted to a set amount each year.
A family can provide an ICHRA to their employees if they don’t already offer a QSEHRA or an Excepted Benefit HRA. They also can’t provide a traditional group health insurance plan as well as an ICHRA at the same time.
With an ICHRA, employees pay for their individual health insurance premiums and/or medical expenses and then submit receipts for reimbursement from their employer.
By offering an ICHRA as part of a total compensation package (like the QSEHRA example above), household employees can reduce their taxable income meaning a lower tax responsibility for the employer and their workers.
5. Flexible Spending Account (FSA)
Flexible spending accounts are funded by an employee with pre-tax dollars up to $3,050 annually. Funds are used to pay for certain medical and dental expenses for the employee, their spouse, and their dependents. Some qualified expenses include:
- Health insurance deductibles and co-payments (but not premiums)
- Prescription medications
- Over-the-counter medicines with a doctor’s prescription (reimbursements for insulin are allowed without a prescription)
- Medical equipment and supplies like crutches, bandages, and diagnostic devices like blood sugar test kits
Employers can – but aren’t required to – make contributions to their employee’s FSA.
Since money is taken out on a pre-tax basis, an employee’s taxable income is reduced meaning both the employer and the employee may be able to lower their tax responsibility.
6. Educational expenses and student loans
As an employer, you can make tax-free payments of up to $5,250 per year toward your worker’s qualified educational expenses such as tuition and textbooks.
The CARES Act of 2020 temporarily expanded that law to include student loan repayment assistance as a qualified educational expense. The 2021 stimulus package extended this provision through 2025.
Similar to a QSEHRA, payments toward an employee’s qualified educational loans can be excluded from your worker’s taxable income, lowering their gross wages and resulting in tax advantages for both you and your nanny.
Contributions made in excess of the monetary limit are generally considered taxable wages subject to all employment taxes.
Also, the maximum amount includes either education-related expenses, student loan payments, or a combination of both.
7. Qualified transportation and parking expenses
Your employee can aside $300 (2023 contribution rate) in pre-tax dollars each month for transportation expenses and that same amount for parking expenses. This reduces their gross income and lowers both their and your tax obligations.
Transportation expenses include public mass transit (subway, train, busses, ferries, etc.) passes, tokens, farecards, and vouchers as well as vanpooling. Driving expenses such as tolls and gas are not qualified expenses and are not eligible for pre-tax reimbursement.
Parking expenses include fees incurred when parking at or near your home and parking at or near a location from where your employee commutes via mass transit or commuter highway vehicle.
Qualified bicycle commuting reimbursements are no longer eligible as a tax-free benefit. However, you provide the bicycle benefit as a taxable benefit.
GTM can help
Have questions about reducing your nanny tax obligation? Get a complimentary, no-obligation consultation with a household employment expert by calling (800) 929-9213. Or schedule time with us at your convenience.
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