Congress Should Fix the Nanny Tax

  • January 18, 2024
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Adam N. Michel

The federal government makes hiring a nanny or other household employee a labyrinthine nightmare of tax, labor, and immigration law. These rigid rules decrease childcare options and increase costs for families and childcare providers. Congress could add flexibility by allowing household employees to work as independent contractors, bypassing much of the complexity.

If a family pays a household worker—nanny, maid, gardener—$2,700 or more in 2024, they are considered “employers,” and the individual providing the service is an “employee.” That threshold is easily surpassed by hiring a babysitter for four weeks a year at the DC minimum wage of $17 per hour.

Triggering the IRS thresholds can come with requirements to pay, collect, and remit income, payroll, and unemployment taxes. It also requires registering as an employer with federal and state governments, collecting and retaining employment eligibility verifications, carrying a worker’s compensation insurance policy, and displaying Department of Labor employee rights notices in your home (yes, the same ones hanging in your lunchroom you’ve probably never read).

Not complying with these rules can trigger tens of thousands of dollars in fines and penalties.

These rules are ostensibly in place to protect the household employees. Instead, their cost and complexity push many parents and workers into the grey economy—often unknowingly opening them up to legal liabilities and tax penalties. The rules also incentivize the use of less flexible third‐​party service providers and institutional childcare that raises costs for families and lowers pay for providers.

To fix this, Congress could allow families and nannies the flexibility to bypass the formal employment rules by allowing them to elect independent contractor status. In 2020, Rachel Greszler proposed such a reform to allow more flexibility for families and workers, writing, “Congress should create a safe harbor to allow individuals performing household work to choose to be treated as contractors instead of household employees, if they prefer such treatment.” Households would still have to report wages exceeding $600 a year to the IRS. This is a much more reasonable requirement. Greszler explains that “this choice would allow individuals to receive higher base pay as contractors because of the compliance and tax savings for the household they serve.”

The complexity of household employment relationships is not unique. Existing definitions of employer, employee, and independent contractor are often ambiguous and contradictory under tax law, the Fair Labor Standards Act, the National Labor Relations Act, and as many as 25 other laws that cover employment arrangements. These definitions are ripe for reform—or at least standardization and clarification.

One such attempt is Senator Mike Lee’s 21st Century Worker Act, which creates a bright line test to determine a worker’s employment status and standardizes definitions across the major tax and employment laws. The bill also allows a safe harbor election for workers and employers to choose their legal status in ambiguous cases. If mutually agreed, similar safe harbor treatment should be afforded to individual households and their service providers.

In‐​home childcare’s tax and regulatory cost is only one small facet of a much broader policy discussion covering family affordability and declining fertility. For example, Ryan Bourne discusses how state and federal policies, more broadly, unnecessarily raise the cost of childcare. Vanessa Brown Calder and Chelsea Follett provide an excellent overview of fertility trends and reforms that would make family life easier for Americans with children. Alex Nowrasteh recently outlined how new proposed regulations could end affordable childcare services provided through the Au Pair Program.

As a new parent who considers himself relatively well‐​versed in tax law and adept at figuring out the arcana of government programs, I naïvely assumed that legally hiring in‐​home childcare would be reasonably straightforward. I was wrong. Even with a plethora of online payroll services, faithfully navigating state and federal tax and employment law is a nightmare.

The cost and complexity incentivize families to use formal center‐​based childcare and make it more likely that household employees operate in grey markets that expose families and workers to steep penalties and back taxes. Allowing an opt‐​out would benefit families and caregivers.