While the process of finding and negotiating a contract with an experienced, qualified nanny may seem like an overwhelming task, it often pales in comparison to the difficulty of navigating the complex world of nanny taxes and payroll requirements. For parents that employ a nanny and own their own business, adding their childcare provider to the payroll of that business may seem like the path of least resistance. The misconception that adding a nanny to the business payroll is a quick and easy fix to ensure that her employment taxes are paid accurately and legally is a common one; however, the IRS and federal tax laws prohibit this arrangement in most cases and severely limits it in others, which can easily elevate a mildly complicated annoyance to nightmare status when a mistake with good intentions leads to audits, back taxes, and penalties, among other possibilities.
Business Tax Deductions
The tax deductions that businesses are allowed to claim as a result of payroll expenses are one of the reasons why business owners aren’t allowed to pay their nannies through the company payroll without meticulous documentation. Because the IRS does not consider any domestic workers or household employees to be contributors to the success of a business, their salary can’t be reported on a business tax return. Instead, employers of domestic workers are required to pay their wages through a personal, household account.
In some cases, it may be legal to pay your nanny or other household employee through your business payroll, but even those specialized cases require scrupulous accounting practices to ensure that no deductions on her payroll are taken. While the process is technically legal, it’s almost never recommended due to both the potential for error and the increased legal risk. For-Profit farms and Sole Proprietorship businesses are the only exceptions to the reporting requirements.
Most states require that the employers of domestic workers, including nannies and housekeepers, carry workers’ compensation insurance to cover medical expenses and lost wages in the event of a work-related injury that requires medical attention. Workers’ compensation policies for a business located outside of your home will almost never cover a household employee; the policies designed for such purposes are usually riders for homeowners’ policies. Paying your nanny through the company payroll is likely to jeopardize her workers’ compensation coverage, leaving you potentially liable for her medical expenses and under scrutiny for insurance fraud.
Similarly, the group health insurance plan that covers employees of your business isn’t likely to allow coverage for personal employees, which includes any domestic workers that you may employ. Attempting to include her on a group health plan may also create the potential for charges of insurance fraud; at the very least, any claims she submits are likely to be denied. Depending upon the insurance requirements of your individual state, there may be other factors that preclude you from listing your nanny among the employees of your business.
The best way to avoid a costly and unlawful tax mistake is to pay your nanny and any other domestic employers through a separate, personal account and consult a reputable tax professional and payroll firm, like Breedlove & Associates, that has experience dealing with domestic worker tax requirements. Often, these erroneous and illegal arrangements are suggested by tax professionals who have the best intentions, but a murky understanding of the very specific tax codes that govern domestic workers and household employees. In addition to preventing any confusion and inadvertently illegal deductions, paying your nanny through a household account may also allow you to take advantage of the Child and Dependent Care Tax Credit, which permits eligible taxpayers to apply up to $6,000 of childcare expenses towards a tax credit on their personal tax returns. There are also software programs that are specifically designed to help families that employ domestic workers to accurately calculate, document, and file their tax returns without resorting to an accountant or expensive professional. Whichever method you choose, it’s very important that you remain compliant with tax codes; paying your nanny “under the table” by not reporting her income or paying any employment taxes can create a much bigger mess than trying to add her to the payroll of your own business.
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