U.S. Markets closed

4 Ways to Save on Child Care

Stephanie Breedlove

Did you know that if you pay your nanny, babysitter, or other child care professional more than $1,900 a year to watch your kids, you also have to pay employer taxes?

This additional expense causes many families to worry that they can’t afford in-home care. But that’s definitely not the truth! There are several ways you can offset your employer tax liability — even to the point where you actually save money. As long as you pay your nanny on the books, these four benefits can make a big difference to your bank account and help you save on child care.

1. Enroll in a Dependent Care Account.  Most businesses give employees the opportunity to enroll in a Dependent Care Account (also known as a Flexible Spending Account) during the open enrollment period — usually in the fall. You can contribute up to $5,000 to help pay for child care expenses, such as your nanny’s wages. This means you don’t have to pay federal income tax, state income tax or Social Security and Medicare taxes on this amount. Depending on your tax bracket, a Dependent Care Account can save you around $2,000 per year.

2. Take the Tax Credit for Child or Dependent Care. Families that don’t have access to a Dependent Care Account can use the Tax Credit for Child or Dependent Care. By using IRS Form 2441, you can claim up to $3,000 of child care expenses if you have one child or $6,000 if you have two or more little ones. The tax savings is based on your income, but you may see about a 20 percent savings, which can translate to a tax break of up to $600 for one child or $1,200 for two or more kids.

If you have two or more children and have access to a Dependent Care Account, you can utilize the full $5,000 of your Dependent Care Account AND claim an additional $1,000 on the Tax Credit for Child or Dependent Care for the excess expenses. This will save you an extra $200 per year.

3. Consider a Nanny Share.  If you don’t think you can afford a professional caregiver to take care of your child, a nanny share may be the best option. You join forces with another family who has kids, and hire one nanny to watch all of the kids together. The two families will split the cost of the caregiver’s wages, but, in the eyes of the IRS and state tax agencies, they are separate employers and will still pay employer taxes — just like any other family with a caregiver would do.

It’s very important that both families are on board with this arrangement. Although it would seem easier for one family to handle all the tax withholdings and payments and have the other family reimburse these expenses, the reality is that one family would not be compliant with the law. Additionally, there’s always risk when one family pays the caregiver in full and then has to collect money from the other family.

When you properly execute a nanny share, both families are eligible for the tax breaks described above. And because their employer taxes are essentially half of what they would be if they each hired their own personal caregiver, the tax breaks have a good chance of outweighing each family’s tax liability. This means both families save money by paying the caregiver legally!

4. Consider Non-Taxable Compensation. According to the law, the wages you pay your nanny must be taxed. However, there are other means of compensation you can provide that are considered “non-taxable,” meaning neither you nor your sitter has to pay any taxes on it.

  • Tuition and books: If the nanny is a college student at an accredited college or university, you can contribute up to $5,250 toward the cost of tuition and books.
  • Public transportation: You can pay up to $245 per month for your sitter’s mass transit cost to get to and from your home.
  • Parking: If your caregiver has to pay to park at your home or at a public transportation facility, you can contribute up to $245 per month to offset those costs.
  • Health Insurance: You can pay for or partially contribute to your nanny’s health insurance premiums. (Rather than giving this money to your sitter, you should pay the insurance company directly to make sure the money is being used for health insurance.)

With each of these forms of non-taxable compensation, your nanny saves on her out-of-pocket expenses. Your savings are based on the amount of taxes that would have been due if you had given your caregiver the money to pay for these expenses.

As you can see, the cost of in-home child care doesn’t have to break the bank. Strategically structuring payroll and taking advantage of tax breaks can minimize your family’s tax liability — and in some cases — even save money. The work involved is a small price to pay, especially when that price is usually only your time, rather than a large chunk of cash!

Stephanie Breedlove is the Vice President 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.

More from Manilla.com: