Hiring a Caregiver for Your Child: What Are Your Tax and Legal Responsibilities?

December 4, 2013

This guest post was written by Stephanie Breedlove from Care.com. If you'd like to submit a guest post, send us an email at dimecontact@copera.org.

When you hire someone to work in or around your home (like a babysitter or nanny), you're considered a "household employer." In the eyes of the IRS, you're now a business with an employee -- just without an accounting or HR department.

This can be overwhelming for some families, but actually, the tax rules in Colorado are very typical of most other states in the country. And the good news is that if the payroll and taxes are handled correctly, the federal government has ways for you to save money on your employer costs.

So take a look below for a "Tax Law 101" overview for household employers in Colorado.

What Are My Tax and Legal Responsibilities?

1. Treat your nanny, babysitter, etc. as an employee. There's a common misconception on parenting forums and websites that these caregivers are independent contractors and can be given a Form 1099 during tax season to file their own taxes. Not true! Not only has the IRS definitively ruled that this is incorrect, but they also consider the practice to be worker misclassification -- a form of tax evasion. And you don't want to deal with a headache like that. Instead, prepare a Form W-2 and give it to your employee at year-end so they can use it to file their federal income tax return.

2. If you pay your employee $1,800 or more during the calendar year, you have tax responsibilities. This threshold is in place to not burden families who only have an occasional babysitter watch their kids -- and it will increase to $1,900 in 2014. But if you need regular child care, you should withhold payroll taxes from your employee, including:

  • Social Security and Medicare (FICA)
  • Federal and state income taxes, based on how your employee fills out the federal Form W-4. (The same information will be used on the state level because Colorado does not have its own W-4.)

Additionally, you have to pay employer taxes based on a percentage of the wages you pay your employee.

  • Social Security and Medicare taxes and federal unemployment insurance taxes (four times per year to the IRS, along with the FICA taxes withheld from the employee)
  • State unemployment insurance taxes (every quarter to the Colorado Department of Labor)

3. Prepare and file year-end paperwork. Along with giving a W-2 to your caregiver, you have to file Form W-2 Copy A and Form W-3 with the Social Security Administration and file a Schedule H with your federal income tax return.

4. Follow federal and state labor laws. Household employees are protected under the Fair Labor Standards Act, which means they must be paid at least the Colorado state minimum wage of $7.78 per hour (higher than the federal minimum wage of $7.25) for the first 40 hours they work in a 7-day workweek and overtime (time-and-a-half) for any additional hours. The only exception to this rule is if you have a live-in employee --then you just pay your employee for every hour they work.

What Are the Benefits of Doing All This Work?

Why do you have to go through all this extra paperwork and hassle? First of all, it's the right thing to do, from a legal standpoint. There's never a worry about a legal dispute from a disgruntled former employee or an audit from the state or IRS when everything is handled correctly. But here are a couple of other benefits you get when you pay "on the books."

1. Tax breaks offset the employer taxes. Most families qualify for tax breaks -- regardless of their income level -- when they pay on the books. There are two tax breaks available that can significantly decrease your tax costs.

  • Flexible Spending Account (FSA): Also known as a Dependent Care Account, an FSA allows you to pay for up to $5,000 of child care expenses (a caregiver's wages qualify) using pre-tax dollars. Because no Social Security, Medicare or income taxes are applied to this amount, most families save around $2,000 per year by enrolling.
  • Child or Dependent Care Tax Credit (IRS Form 2441): You can save as much as 20 percent on up to $3,000 of child care expenses per child per year (maximum of $6,000). For most families, this tax break will save up to $600 for one child and $1,200 for two or more children.

2. Your employee is treated like a professional. When you pay on the books, your caregiver receives important short-term and long-term benefits, such as Social Security, Medicare, unemployment and an ability to obtain loans and credit. These benefits and protections have a dramatic impact on the perception of the position. When caregivers feel like they're treated like professional workers, they tend to provide high-quality work and are more likely to stay with families for a long time.

So whether you hire a full-time nanny to care for your kids while you're at work, or ask a babysitter to watch your kids during your regular Friday date night, make sure you're crossing your t's and dotting your i's. It's easier than you think!

Stephanie Breedlove is the VP of Care.com Homepay, where she helps families to simplify and understand their responsibilities as employers of caregivers or household workers. She is one of the country's leading experts on household employment tax and labor law. When she isn't busy keeping up with her two grown boys, Stephanie enjoys spending time outdoors in and around the Austin area hiking, biking and fishing.