Why the Nanny Tax Threshold Matters
The U.S. Social Security Administration (SSA) recently increased the domestic employee coverage threshold to $2,400 for 2022, up from $2,300 in 2021, marking the third consecutive year the threshold has been increased. The amount is set each year by the SSA, and it serves as a good reminder to check in with your clients who have or may have hired household help this year.
Nanny Tax Threshold
Commonly called the “nanny tax” threshold, any wages paid to domestic workers at or above that amount triggers Social Security and Medicare (FICA) tax obligations for employers and their employees. For household employees, the amount changes according to the national average wage index. Earnings below this threshold are not taxable under Social Security; however, earnings that exceed the threshold are subject to FICA.
For most industries, there is no coverage threshold, so every dollar of wages is covered and taxable. Household employment, however, is one of the few industries with a coverage threshold. Forgetting about it is understandable but can be costly for your clients.
Not Just for Nannies
While we typically think of domestic workers as nannies, in-home caregivers, housekeepers and estate staff, other workers that can be considered household employees include private educators, tutors, summer nannies and babysitters with regular hours.
Even if your client employs only a part-time or seasonal worker, the nanny tax threshold can be reached. A summer nanny working 40 hours per week at $15 per hour will reach the threshold after only four weeks of work. An after-school nanny putting in 15 hours per week at the same rate will meet the nanny tax threshold just a few months into the school year. If your client hired a private teacher to supervise or supplement virtual learning, the threshold might be reached even if the employee worked for only a few months in 2021.
It is important to know if your client hired someone to work in their home during 2021 and whether employment taxes apply. However, your client does not need to pay nanny taxes on wages paid to their spouse, children under the age of 21, parent or any employee under the age of 18.
Employment Tax Obligations
Social Security and Medicare taxes are 15.3 percent of an employee’s cash wages. The employer (in this case, your client) pays 7.65 percent (Social Security at 6.2 percent and Medicare at 1.45 percent), while the same amount can be withheld from the employee’s pay, or the family can pay their worker’s share and not withhold.
Keep in mind that taxes paid to cover an employee’s share of FICA must be included in their wages for income tax purposes. They aren’t counted as Social Security and Medicare wages or as federal unemployment wages.
Most states also follow the federal nanny tax rules. These taxes can be remitted quarterly using Form 1040-ES. Another option is for your client to increase the tax withholdings from their own pay to help cover their household employment taxes that will be due when they file their personal tax return. Failing to account for nanny taxes can result in underpayment penalties.
Unemployment Tax Threshold
Your clients with household help may also owe federal and state unemployment taxes. If they pay their household employee $1,000 or more in any calendar quarter, they need to pay federal unemployment taxes of six percent on the first $7,000 in wages. State unemployment taxes vary, but typically they are triggered at between $500 and $1,000 in quarterly wages.
Families may be able to take a credit against their federal unemployment tax if they also pay state unemployment. The credit could be as much as 5.4 percent, which will drastically reduce the amount owed for federal unemployment.
Outside of a few states (Alaska, New Jersey and Pennsylvania), unemployment is an employer-only tax. Wages paid to a spouse, a child under the age of 21 or a parent do not count toward unemployment taxes.
Withholding Income Taxes
Another wrinkle in household employment is the option for the employer to withhold income taxes from their worker’s pay. While it is not required, it is highly recommended, as doing so ensures the employee is not stuck paying their entire income tax obligation when they file their personal tax return.
Reconciling Employment Taxes
If the nanny tax and/or unemployment threshold is met, household employers can reconcile their employment taxes on Schedule H, which is filed with their personal tax return. The employee receives Form W-2 by January 31. Form W-3 and a copy of Form W-2 must also be filed with the SSA by that date.