The Hidden Costs of a Babysitter

May 20

One of the biggest lessons learned my family had when officially hiring a babysitter (or what many call a nanny) was not understanding nanny tax. Yes, nanny tax is a real thing and it can be a huge financial burden for you. The IRS officially calls this “employment tax for household employees.” I am going to share our experience with you in the hopes that this helps you understand the financial commitment you are making when you “officially” hire a babysitter or nanny.

We do not talk about a babysitter and nanny in the same way which can make this confusing. Many of us use the terms babysitter and nanny interchangeably but we don’t always mean the same thing. Here is my opinion of it:

Babysitter: Someone who provides care for your child on an inconsistent basis with their main focus being the safety and well-being of your child when under their supervision. Someone who comes a couple times a month for 3-4 hours to give the caretaker a date night, to help out when a caretaker has to work late, or when a caretaker may be ill.
Nanny: Someone who provides consistent, routine childcare with their main focus being on child development. Someone who comes 4 days per week on a set schedule (8am – 6pm) while the caretaker(s) work.

To me, the distinction between a babysitter and nanny is clear.

How does the IRS Define a Babysitter and Nanny?

The IRS defines and classifies both a babysitter and a nanny as a “household employee!”

“You have a household employee if you hired someone to do household work and that worker is your employee. The worker is your employee if you can control not only what work is done but how it is done. If the worker is your employee, then it does not matter whether the work is full time or part time nor that you hired the worker through an agency or from a list provided by an agency or an association. It also does not matter whether you pay the worker on an hourly, daily, weekly, or by the job.”
“Household work is work done in or around your home. Some examples of workers who do household work are:
- Babysitters
- Caretakers
- Cleaning people
- Domestic workers
- Drivers
- Health aides
- Housekeepers
- Maids
- Nannies
- Private nurses
- Yard workers”
The nanny tax does not apply to wages paid to a spouse, a child under the age of 21, a parent, or any employee under the age of 18.
Additional information – the nanny tax varies from state to state. Checkout Care.com Nanny Taxes by State for more information.

Okay, I definitely panicked when I learned about this. My interpretation of reading this is if I can control the routine and I set expectations for caring for my child, then having either a babysitter or nanny makes me an employer. I, as a parent, am an official employer who has an employee and must follow certain employment laws like paying taxes!

I’ve always thought childcare was expensive but now having to pay out of pocket for both a high wage AND pay taxes on top of that? That is even more expensive than I ever imagined. Let’s dig in more to the requirements, actual cost, and tax for a babysitter or nanny under the “nanny tax.”

*Disclaimer – this is my interpretation of public information. I am not an accountant or attorney.*

Breaking Down the IRS “Nanny Tax” Requirements

We have already defined a “household employee” – see above – which is an important starting point.

You, as a caretaker are now considered an Employer. As an employer, you must apply and gain an Employer ID from the Federal and State government.

Federal website short link: IRS.gov/EIN
Average turnaround time: Immediate
Cost: $0. It is free to do this, beware of websites that charge you for this.

Once you get your Federal Employer Identification Number (EIN) then you can apply within your State.

Now that you are an official Employer with an ID, you now must learn about your taxes. There are federal and state taxes that apply when you pay a household employee more than $2,700 (as of 2024) over the course of a year.

Federal taxes include Federal Social Security Taxes and Medicare Taxes – which are classified under the Federal Insurance Contributions Act (FICA). Federal taxes also include Federal Unemployment Taxes when they pay their employees more than $1,000 (as of 2024) in any quarter of the current or preceding calendar years. The employer needs to contribute federal unemployment taxes of six percent on the first $7,000 in wages. The combined total tax rate for these three taxes is 15.6% as of 2024.

State taxes may also include Payroll Tax, State Unemployment Insurance Contributions, and Disability and/or Worker’s Compensation Insurance. The combined total tax rate for these taxes varies from state to state. We estimated ours, in the state of Michigan at 5.3%.

Who pays these taxes and how do you setup yourself up to appropriately meet these cost requirements? As you are now fully aware, you are an employer and a business. You may consider hiring a payroll agency or complete payroll responsibilities yourself.

Payroll agency – there are many benefits to hiring a payroll agency. You know that they are experts in this and can help you be compliant with the law. They can also help you if you have had a household employee before knowing about the Nanny Tax requirements to correct your payments and tax requirements. The payroll agency can also produce official W-2 forms for your employee during tax filing season. Additionally, if you are using a Flex Savings Account (FSA) to pay your nanny, then you absolutely need to report that correctly because you are already in the “IRS system” for FSA tax purposes. Obviously, a payroll agency is an additional cost to your bottom line. The average cost of a payroll agency can be between $600 - $1,000 annually.

Do Payroll Yourself – I am sure you can learn how to do this yourself and I also didn’t have the time or brain space to figure that out and feel confident in it. Especially with requirements to submit estimated wage payments 4 times per year to the Federal government on 1040s. Totally up to you.

Is there a way to reduce the cost to you, as the employer, for a babysitter or nanny? Well, you could talk to your employee about who is going to pay the taxes on wages. You, as the employer, can obviously pay the tax or you could put the responsibility of taxes on your employee. That would be a conversation you need to have with your employee. You do still have to become and Employer with an ID, abide by all federal and state taxes, appropriately track payroll for your employee, and provide appropriate tax-filing documentation such as a W-2.

Which brings me to another requirement – how you file your taxes now that you are an employer. This makes it more complicated and difficult to self-file your taxes, especially the first year you become an employer.

As an employer, you now have to file a W-3 and a Schedule H form as part of your taxes.
You also have to use your Employer Identification Number to appropriately log and file the taxes of your business and your employee.
Your State may also require an annual reconciliation form summarizes all payments made to your employee.
Additionally, this is where having the right W-2 form for your employee is critical.

Insurance for a Household Employee

Many states also require for you, as the employer, to obtain worker’s compensation insurance for your employee. The actual requirements vary from state to state depending on hours worked and pay but many states do require this. Your current homeowners, condo, or renters insurance does not typically cover this expense and having additional worker’s compensation insurance can safeguard you against certain risks. Common insurance for household employees can cover:

Personal liability
Employment-related claims
Damage to property
Workers’ compensation

If your employee does get injured on the job and you don’t have worker’s compensation insurance, then you would be personally responsible for paying medical expenses and lost wages out of pocket.

Paying Someone “Under the Table”

You are looking at all of this and thinking – umm… no thank you, I’m just going to pay my babysitter or nanny “under the table.” This is a big IRS no, no and yet many families do this. There is a pretty big financial risk you take when paying someone under the table. I don’t openly support paying an official household employee under the table but I completely understand why families do. There are some things you might want to be aware of if you are paying someone under the table.

You can be charged with tax evasion for misclassifying or omitting from claiming your nanny. You cannot classify your nanny as an independent contractor or provide a 1099 Form. Tax evasion sounds terrifying yet many people do this.
If, at any point, you have to part ways with your nanny they may file for unemployment. If or when they file for unemployment, they will be refused benefits and that may trigger an audit from the IRS. You will be required to pay back taxes along with penalties and interest. With the potential of being charged for tax evasion and potentially losing any professional licenses you have.
Be aware that if you are using a Flex Savings Account (FSA) through your employer to pay for your babysitter or nanny “under the table” that you are already in the “IRS System” for taxes related to your FSA. If you set aside money in an FSA, you have to claim that on your individual tax return. If you then use money from your FSA to pay for a nanny or babysitter, then the IRS can track that and flag you for an audit or penalties if you do not appropriately claim a babysitter or nanny. Be aware of this!
Also be aware if you are paying an official household employee through Venmo or other cash apps like PayPal. “Venmo’s IRS 1099-K tax reporting requirements only pertain to payments received for sales of goods and services and DO NOT apply to friends and family payments.” There are required reporting for payment transactions that exceed $20,000 and 200 transactions. Some states have lower reporting thresholds. The IRS actually requires Venmo and other cash apps to report payment activity if you reach the reporting threshold for these transactions.

Additional Information

I was recently made aware of additional benefits and perks that a nanny could be offered as an employee and some potential expectations you, as an employer may need to provide. I was informed on “industry standard benefits for professional nannies” which include:

Guaranteed pay
Paid holidays
2 weeks of PTO
1 week of paid sick time
Mileage reimbursement

In addition to these industry standards, I have seen optional benefits for nannies including:

Health insurance stipend
401k contribution
Education assistance / student loan support

This information is based on the state of Michigan and could vary from location to location. I was, again, really surprised by this information. Yet, when we were searching for a nanny through Care.com and other agencies, many nannies did ask for guaranteed pay and mileage reimbursement. Something for you to consider as you are budgeting and searching for the right fit.

Total Cost Comparison

*Disclaimer – I am not supporting paying under the table, I’m showing a cost comparison for frame of reference.*

*Does not include penalties or interest for not following tax law.

My Personal Experience

My husband and I have previously hired a nanny to care for our son. It is the childcare we preferred, fit our parenting style and our son’s needs, and we were financially able to pay for it. When we hired our nanny, we did not understand the implications of the nanny tax. We thought we were being smart by setting aside funds in our FSA to help pay for our nanny expenses. Yet, we did not fully understand what I have just outlined in this article. When tax season came around, our accountant shared with us that we were in violation of the IRS household employee tax and corresponding federal and state laws.

To hear that made me feel absolutely sick. We had no idea how to fix our mistakes or the associated cost. We had to go through an expedited process to file for an Employer ID, hire a payroll agency to fix all of our payments, pay penalties, and pay our accountant more to file our taxes appropriately. To say this is something I will never forget is an absolute understatement. I can still feel how sick I felt and how big of a financial hit we took to get into compliance.

Knowing what I know now, I never want another caretaker to be caught off guard by the requirements, financial impact, and associated risks from paying someone under the table. I think the IRS threshold of $2,700 per year for paying taxes on a household employee is ridiculously low and basically captures everyone in the “household employee” category for annual earnings. I also believe the amount of hoops someone has to jump through and the additional money caretakers have to spend to set themselves up as an employer is insane.

The rising costs of childcare pushes more and more people to explore options outside of traditional daycare centers. There are MANY hidden costs in hiring a babysitter or nanny. Even if you have the funding to pay someone as a nanny, it can sometimes be as expensive OR even more expensive than a daycare because of the fees and taxes you have to shoulder.

I hope this was very informative to you and that you are able to understand the structure, fees, and requirements for hiring a babysitter or nanny.

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