Understanding the Critical Distinction: Employee vs. Independent Contractor
Correctly classifying your nanny as an employee or independent contractor is essential for proper tax reporting. The IRS determines this based on the level of control you have over the worker. An independent contractor is self-employed and controls their work, while a household employee has their work controlled by the employer [1, 2]. Since you typically control a nanny's schedule, duties, and how the work is performed in your home, they are almost always considered a household employee [1].
Why a Nanny Is a Household Employee
The IRS classifies nannies as household employees because the family typically controls what work is done and how it is done, such as setting hours, daily activities, and house rules [1, 3]. Examples of this control include determining work hours, outlining daily tasks, and providing necessary equipment [1, 3].
If you pay a nanny over the annual wage threshold ($2,800 for 2025), you become subject to household employer tax obligations, including Social Security, Medicare (FICA), and federal unemployment tax (FUTA) if cash wages meet the quarterly threshold of $1,000 or more to all household employees [1, 3]. Certain family members may be exempt from these taxes [1].
What Happens if You Misclassify a Nanny?
Misclassifying a nanny as an independent contractor and issuing a 1099 is a common but serious error. The IRS views this as potential tax evasion and can impose significant penalties for willful misclassification [1]. Consequences include liability for back taxes, interest, and penalties for unpaid FICA and FUTA taxes, potential state and federal labor law violations, and an increased risk of IRS audits with no statute of limitations for fraudulent returns [1].
The Proper Process: W-2 and the 'Nanny Tax'
To comply with tax laws, household employers must follow specific steps, often referred to as the "nanny tax" process [1, 3]. This involves obtaining an Employer Identification Number (EIN), collecting necessary forms like Form I-9 and Form W-4 from your nanny, ensuring proper wages (at least minimum wage and overtime), and calculating and paying both the employee's and employer's share of taxes [1, 3]. Annually, you must file Schedule H with your Form 1040 and provide your nanny with a Form W-2 by January 31st, also sending a copy to the Social Security Administration [1, 3].
Employee vs. Independent Contractor: A Comparison Table
| Characteristic | Household Employee (e.g., Nanny) | Independent Contractor (e.g., Plumber) |
|---|---|---|
| Control | You control what work is done and how it's done. | The worker controls how and when the job is completed. |
| Work Location | Work is done in or around your home. | Work is often done at their own site or as needed. |
| Supplies | You provide the necessary supplies and equipment. | The worker provides their own tools and equipment. |
| Tax Reporting | You provide a Form W-2 for wages. | The worker receives a Form 1099 (if applicable) and pays their own taxes. |
| Taxes Paid | You and the employee split FICA taxes; you pay FUTA. | The worker pays the full self-employment tax. |
| Legal Obligations | You must comply with federal and state wage, tax, and labor laws. | You have minimal legal obligations as the client. |
What About Hiring Through an Agency?
If you use a nanny agency, clarify if they are the employer or just a referral service. If the agency is the employer, they handle payroll and taxes. If you hire a nanny directly through a referral agency, you are the household employer responsible for all tax obligations [3].
Conclusion
Properly classifying and paying your nanny according to IRS rules is vital for avoiding legal and financial penalties. Most nannies are considered household employees, requiring a W-2 form, not a 1099. Following the correct process ensures tax compliance and provides your caregiver with necessary benefits. For detailed information, refer to the official IRS Publication 926, the Household Employer's Tax Guide [1].
