How to Pay Your Nanny Legally in 2021 and Save Money

Mar 18, 2021 | GTM Blog, Household Payroll & Taxes, Tax & Wage Laws

It’s always the right thing to do, but with expanded childcare tax credits and increased contribution limits on Dependent Care FSAs through the American Rescue Plan, paying your nanny legally may now be cheaper than “under the table.”

Some of the financial provisions that are part of the American Rescue Plan help reduce childcare costs for families. They also provide a significant incentive for household employers to pay their nanny legally as tax breaks are not available to families who pay “off the books.” If there was ever a time to start paying your nanny the right way, it is now.

Let’s take a look at key parts of the plan and how they cut the costs of childcare and incentivize legal pay.

Increased contribution limits to your Dependent Care FSA

Many companies offer their employees some type of dependent care assistance program in the form of a flexible spending account (FSA). In past years, you could contribute up to $5,000 in tax-free money to a Dependent Care FSA and then get reimbursed for qualified expenses like wages paid to a nanny. This type of account lowers your taxable income so you pay less in Social Security, Medicare, and federal income taxes (state taxes too if applicable).

The American Rescue Plan boosts the dependent care FSA limit to $10,500 for 2021. Depending on a few factors – like where you live and your total income – you could save anywhere from 35 to 46 percent on the funds you place in a dependent care FSA. That means if you have at least $10,500 in childcare expenses (again this includes wages paid to a nanny) and max out your FSA and you could save $3,300 – $4,700.

Check with your employer’s human resources department to see if they plan to increase your contribution limit to a Dependent Care FSA.

Expanded Child and Dependent Care Tax Credit

Under the American Rescue Plan, the Child and Dependent Care Tax Credit will increase from $3,000 to $8,000 for a family with one child. For families with two or more children, the credit increases from $6,000 to $16,000. These increases are for the 2021 tax year and will be reflected when you file your tax return next year.

A nanny’s wages are considered a qualifying expense under the Child and Dependent Care Tax Credit.

The amount of the credit gradually decreases based on a family’s household income from 50 percent of qualifying expenses for households with an adjusted gross income (AGI) of less than $125,000 to one percent for households with an AGI of $440,000.

We break down the income brackets and percentages here.

That means a family with an AGI of less than $125,000 would get a tax credit of $4,000 for one child or $8,000 for two or more children.

Right now most families get a 20 percent credit of childcare expenses ($600 for one child or $1,200 for two or more children). With the American Rescue Plan, a family with an AGI of $185,000 – $400,000 can get that same 20 percent credit but now would get $1,600 for one child and $3,200 for two or more children.

Maximizing your tax savings

In 2021, if you have two or more children, you can apply up to $16,000 of childcare expenses towards tax breaks (Dependent Care FSA and the Child and Dependent Care FSA). The maximum is $8,000 for one child.

If you have a nanny caring for your two children, you can apply $10,500 of their wages to your Dependent Care FSA and use the remaining $5,500 for the Child and Dependent Care Tax Credit.

Let’s say you employ a full-time nanny earning more than $16,000, file as married filing jointly, and have an AGI between $185,000 and $400,000.

For one child, your tax savings would be:

Dependent Care FSA: $3,300 – $4,200 (based on a maximum contribution of $10,500 and depending on your tax bracket)

Child and Dependent Care Tax Credit: $1,600 (20 percent of $8,000 of qualifying expenses)

In this scenario, if you max out your Dependent Care FSA, then you wouldn’t be able to take the Child and Dependent Care Tax Credit. If you do not have a Dependent Care FSA, then you would apply the maximum amount of expenses to the tax credit.

For two or more children, your tax savings would be:

Dependent Care FSA: $3,300 – $4,200 (based on a maximum contribution of $10,500 and depending on your tax bracket)

AND

Child and Dependent Care Tax Credit: $1,100 (20 percent of $5,500 of qualifying expenses after accounting for the dependent care FSA)

For a total of $4,400 – $5,300 in tax savings.

In this scenario, you would have expenses leftover even after maxing out your Dependent Care FSA. So you would be able to apply additional expenses of up to $5,500 to the tax credit.

How legal pay will save you money versus “under the table” pay

It always makes sense to pay your nanny legally. In 2021 (and maybe beyond), it can save you money.

Here’s how based on:

Nanny’s gross wages of $25,000
One child
A family filing as married filing jointly
AGI of more than $172,751

Wages before taxes	$25,000
Employer share of FICA	$1,912.50
Federal and state unemployment	$700 (approx.)	cost will vary by state
Total costs before tax breaks	$27,612.50
Dependent Care FSA savings	$3,300 – $4,600 (approx.)	max amount contributed for tax brackets between 24 – 37%
Total costs w/tax savings	$23,012.50 – $24,312.50

That means by paying legally, you may be able to save at least $700 and possibly much more. If you decide to pay for a nanny payroll service like GTM Payroll Services, you may still see savings and have none of the hassles of doing payroll and taxes on your own.

Let’s run another scenario. This time:

Nanny’s gross wages of $40,000
Two children
A family filing as married filing jointly
AGI between $185,000 – $440,000

Wages before taxes	$40,000
Employer share of FICA	$3,060
Federal and state unemployment	$700 (approx.)	cost will vary by state
Total costs before tax breaks	$43,760
Dependent Care FSA savings	$3,300 – $4,600 (approx.)	max amount contributed for tax brackets between 24 – 37%
Child and Dependent Care Tax Credit	$1,100	applying the 20 percent credit to the remaining $5,500 in childcare expenses
Total costs w/tax savings	$38,060 – $39,360

Even by paying more in employment taxes due to higher wages, you could still save at least $600 and likely more by employing your nanny legally. Again, you can use some of that savings toward a payroll service, still come out ahead, and not have to worry about getting payroll and taxes right.

GTM Payroll Services provides these calculations as a means for understanding an estimate of tax liabilities but should not be used as a replacement for formal calculations and does not constitute the provision of tax or legal advice. The user assumes all responsibility and liability for its use.

Legal pay for nannies beyond 2021

The American Rescue Plan limits these tax savings and others – like the Child Tax Credit – to 2021. However, there is a strong possibility that these changes will be made permanent when Congress takes up comprehensive tax reform later this year. That means paying your nanny legally after this year may continue to be a less expensive option than “under the table” pay.

Your nanny benefits too

Pandemic relief legislation, like the American Rescue Plan, has included expanded unemployment insurance, paid sick and family leave, and stimulus checks. By paying legally, your nanny can take advantage of these benefits as well as the other advantages of being paid on the books.

Expert help available for questions on legal pay for your nanny

Have questions about paying your nanny legally? Give us a call at (800) 929-9213 for a complimentary, no-obligation consultation with a household employment expert. Or schedule time with us at your convenience.