Nannies generally don't make headlines except through celebrity infidelities for the likes of Ben Affleck and Arnold Schwarzenegger. But they have drawn attention recently after the release of a study by The Economic Policy Institute showing that only a few cities across the country meet the Department of Health and Human Services' affordability limit, which is 10% of household income. And in most of the areas studied, childcare costs even exceeded the amount paid for rent.
Historically, this issue has only been a concern for lower income families, but wage stagnation for middle and upper income families has caused the issue to creep into the lives of wealthier Americans. So if you are a new parent paying a fortune for childcare, keep the following tips in mind to pay your nanny in the most simple and tax effective way.
Dependent Care Flexible Spending Account
You may not even know that dependent care flexible spending accounts exists at your workplace, but many companies offer this great plan. You can defer up to $5,000 a year per family, so you are never taxed on this amount for federal, state, or social security. Then you periodically apply for reimbursement to cover amounts paid for childcare expenses. Depending on your tax bracket, using this flexible spending option could save you over $2,500 in taxes.
Child and Dependent Care Credit
The dependent care credit is a great alternative to flexible spending accounts. You cannot combine the two options for the same expenses, but you may use up to $3,000 of childcare expenses ($6,000 for two or more children) to calculate the credit, which may be between 20-35% of your allowable expenses, depending on your income.
Most people would like to consider their nanny an “independent contractor,” which basically means that you just pay them an hourly rate without regard to payroll taxes. Unfortunately, nannies are actually “household employees,” and you must treat their pay like any other employer. That means you have to withhold from their paycheck, pay FICA and unemployment taxes, and handle all the associated paperwork. Fortunately, there are inexpensive and easy-to-use payroll services like HomePay that can handle all these administrative tasks electronically.
You want to provide great care for your children, so you hate to think about hiring “cheap” service. But when you do spend a significant amount for childcare, make sure that you are using at least one of these tips to save on taxes or make life easier.
Josh Norris is an Investment Advisory Representative of LeFleur Financial. Josh can be reached at josh@LeFleurFinancial.com.