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Are there any tax breaks a nanny employer can take advantage of?

There are two popular tax savings strategies used by families employing a nanny. A family may choose only one of these strategies to use in any particular year. Additionally, the family must report and pay taxes on the nanny's wages to be eligible for either tax break.

Child and Dependent Care Tax Credit:

The Child Care Credit allows you to apply the first $3000 of expenses ($6000 if you have two or more children) you paid for qualified child/dependent care towards a tax credit. For families earning over $43K in 2007, the credit is 20% of the expenses. Most nanny employers would qualify, therefore, for a $600 or $1200 tax credit.

A tax credit is not a deduction. A tax credit directly reduces the amount of tax you owe the IRS at the end of the year.

To be eligible for this tax credit, there are a number of 'tests' that must be met. The main factors are: 1) the nanny must be employed to care for a qualifying person (your dependent child under 13, disabled spouse, or other qualified disabled dependent); 2) you (and your spouse if married) must have earned income; and 3) the nanny's care must be required so you can work.

 IRS Publication 503

Dependent Care Flexible Spending Account:

The Dependent Care Account is a pre-tax expense account that may be used to help pay for dependent care expenses that are necessary for the parents to work. To participate, the accounts must be offered by the parent's employer as part of flexible benefit plans. The family must elect to participate during the annual 'open season' benefit enrollment period and specify the amount to be deducted from the payroll on a pre-tax basis. The family maximum contribution is $5,000, although, due to IRS regulations, adjustments may be made at year-end for some families earning $85,000 and over in the current year. These amounts are sheltered from Federal income taxes and most state income taxes (New Jersey and Pennsylvania tax these amounts).

A family with adjusted gross income of $80,000 per year would save $1250 in Federal Taxes, and perhaps another $250 - $700 in state income taxes. When available, this is generally the better choice for nanny employers.

Deducting Nanny Expenses

A nanny provides childcare and is a contributing member of a household, not a business. Business owners may directly deduct wages, payroll taxes, and certain benefits provided for the businesses' employees from their business income. Families do not have the ability to do the same on their personal income tax return. A family may only use the two techniques above to use nanny expenses to reduce their income taxes.

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