Tax rules for paying family for in-home care

Published: Mar 27, 2012 3:56 p.m. ET


Paying relatives? The tax implications are complicated


Tax columnist

LOS ANGELES (MarketWatch) — Many baby boomers are facing the economic demands of the sandwich generation, caring for young children and ailing parents at the same time. However, in other families those parents and children provide services, such as a grandparent who takes care of the grandkids or an adult child who cares for elderly parents.

If you’re paying your relatives, the tax implications are more complicated than they appear on the surface. The confusion started back in December, when Jason posted a question to the TaxMama® forum. He hired his mother to care for his baby, so he and his wife could work. He wanted to know what his responsibilities are for reporting her compensation — and how Mom needs to report the income on her tax return.

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This month, we got the other side of the question. Kerry’s father needed someone to care for him. Since she was unemployed anyway, it was the perfect opportunity for Dad to hire her, rather than some stranger. How are these payments meant to be handled from Dad’s tax perspective and Kerry’s?

The nanny tax

Generally, household employees earning $1,800 or more during a tax year must be put on payroll. This is the “nanny tax.” There’s a special IRS form, Schedule H, to report the payroll of household employees.

Household employers are required to file W-2 forms for their employees, along with the annual Form W-3 summary report, but avoid filing quarterly forms. Your state might have a similar system. Or they may require you to file all the quarterly reports, like California does.

The household employer is responsible for their share of Social Security and Medicare taxes, and often also pay the employee’s share. When this is over $1,000 for the year, you will need to make quarterly estimated tax payments, or raise your payroll withholding to cover the taxes.

Are family employees subject to the nanny tax? There are special rules. But the way this information is presented in the IRS publications is so confusing that TaxMama® got it backward. If, after all these years of experience reading tax code and IRS publications, I can’t figure it out, how can you be expected to understand?

Do you treat payments to parents the same way you treat household employees? Mark Luscombe, a principal analyst at CCH, a Wolters Kluwer business, said that since the mother is coming to the married couple’s home, that looks more like a household employee than someone who is self-employed or an independent contractor. Therefore, the IRS indicates that you do not need to pay employment taxes paid to a parent.

So, if you hire your parent to care for your child, like Jason and his wife, you don’t have to file any paperwork with IRS to report your parent’s earnings.

Now that we have CCH’s answer, see if the following — from the IRS’s Household Employer’s Tax Guide — makes sense to you:

Wages not counted. Do not count wages you pay to any of the following individuals as Social Security and Medicare wages, even if these wages are $1,800 or more during the year.

  • Your spouse
  • Your child who is under the age of 21
  • Your parent. Exception — Count these wages if both the following conditions apply: A) Your parent cares for your child who is either under the age of 18, or has a physical or mental condition that requires the personal care of an adult for at least four continuous weeks in a calendar quarter. B) You marital status is one of the following: You are divorced and have not remarried; you are a widow or widower; or you are living with a spouse whose physical or mental condition prevents him or her from caring for your child for at least four continuous weeks in a calendar quarter.
  • An employee who is under the age of 18 at any time during the year. Exception: Count these wages if providing household services is the employee’s principal occupation. If the employee is a student, providing household services is not considered to be his or her principal occupation.”

Note: In the third bullet point above, “count these wages” means do treat those wages as being subject to all payroll taxes.

In other words, you are responsible for paying Social Security and Medicare wages to your parents only if you are a single parent, or have a disabled spouse. When you only have one income and the extra 7.65% cost is a hardship, you have to pay the extra taxes. Who writes these laws?

From Mom’s perspective

Luscombe agreed that Mom does need to report the income. But how? Does she need to file a Schedule C and pay all the Social Security and Medicare taxes herself? If not, how does she get around it, without causing an audit?

Aha! The instructions for Form 1040 list all of the types of income to be reported on line 7 even if no W-2 is received, and how to report it. Luscombe said that for household employee income, the IRS suggests including “HSH” on the dotted part of line 7 with the amount attributable to household employee income listed separately if there is other W-2 income on line 7.

So, when a parent works for you in your home, they will report the earnings as wages, without paying any payroll taxes.

It would be advisable, since this is taxable income, to make quarterly estimated payments to cover the taxes. IRS explains how to do that in five languages on this page.

For elderly parents who hire their children

What about Kerry’s situation? Is she exempt from all the Social Security and Medicare taxes?

No. Since she is over age 18 and not a parent, Kerry is treated just like a household employee, getting a W-2 at the end of the year. Dad should be setting her up on payroll, and making quarterly payments to cover the taxes. The easiest way for someone to handle this nanny tax burden is to use a payroll service. All the major payroll services can help you with this, as well as some of the special services that specifically focus on nanny taxes.

Tax benefits to the payer

There are two types of tax benefits available for all this expense.

  • The Child and Dependent Care Credit – Form 2441. Up to $3,000 per child or dependent (up to two dependents) can be used toward this credit. The credit is typically worth up to $1,200 for two dependents. It’s a nonrefundable credit, so it can only be used to reduce your taxes to zero. Instead of using that credit, set aside up to $5,000 in your flexible spending account to pay your parent and get reimbursed. This saves you more than $1,700 for combined federal and state tax brackets of 30% or more. It reduces your adjusted gross income, increasing other credits and deductions.
  • Medical Expenses – for seniors and children with certain special needs, these care costs may be deductible as medical expenses. Get written prescriptions or letters from medical practitioners to back up the medical need for these services. First use the costs toward the Form 2441. Deduct the excess costs on your Schedule A, as medical expenses. This is especially valuable to seniors with high balances in IRAs or retirement accounts. Do a little planning to withdraw substantial funds from your retirement accounts tax-free. This step is often overlooked in the stress of caring for someone with intense medical problems. The heirs end up paying taxes on all those retirement accounts, needlessly.

Life with children and frail seniors is busy and filled with stress. Hopefully, these tips can reduce a little of the stress — and a lot of the taxes.

Eva Rosenberg, EA, is the publisher of, where your tax questions are answered for free. Eva is the author of several books and e-books, including “Small Business Taxes Made Easy.” Eva teaches tax courses at and CPELINK. Next course: “A Tax Checklist for Knotty Divorces.”

Do you have a passion for taxes? TaxMama is conducting a search for the Ultimate Tax Nerd of 2012. Enter to win prizes, including a Kindle Fire, tax software and more.

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