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more taxes articles

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• Quick Tips: Failing to File
• Starting Up: Avoiding Business Audits

July 25, 2006

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QUESTION: My wife and I both consult through our own two-member LLC. We recently had our first child. My wife cannot work unless we have full time child care. So we're wondering: Can we write off the cost of a nanny as a corporate expense? Should we make the nanny an employee of the corporation?

 

ANSWER: Sorry, hiring Mary Poppins isn't a business expense you can write off as you would a corporate meal or a hotel stay. "It's such a huge expense, but the essence of it is personal, which means the tax code prohibits it," says Donna LeValley, contributing editor to "J.K. Lasser's Your Income Tax 2006" guide.

Some companies — often, large corporations — do offer a child-care perk to employees, sometimes by building on-site day-care facilities, and get a tax benefit for their trouble. While a small business could technically do the same thing, it's typically too cost-prohibitive to start a child-care center, which must be properly licensed by law.

Theoretically, there's one way a couple (in business together) could get a tax break for nanny costs. If one spouse makes the other spouse an employee, then the LLC can contribute $5,000 to cover the costs of the spouse-employee's dependent-care assistance. That $5,000 contribution would be free of Social Security, federal employment, and most payroll taxes. It would basically be taken "out of the mix in terms of taxable income," according to LeValley. For more information, check IRS Publication 15-B, Employer's Tax Guide to Fringe Benefits here.

There are a few catches, of course. This dependent-care benefit must be offered to all employees — so if you hire, say, an assistant, the business must offer the same deal to that person. And there are rules about contribution limits if the employee is highly compensated. In short, it's best to consult a tax advisor, as the rules vary depending on whether the business is structured as an LLC, an S corporation, a sole proprietorship, or a regular corporation.

So why can't you just hire the nanny as a company employee? Labor-law experts say it wouldn't pass muster with the IRS, as the nanny doesn't directly contribute to the success of the business. "It's a big no-no," says Tom Breedlove, of Breedlove & Associates, specialists in household-employment taxes in Austin, Texas. Small-business owners might be tempted to put the nanny on the firm's payroll for a variety of reasons — to write off expenses, or to provide the nanny (especially in a competitive market) with the firm's health-care or retirement benefits. And often, small-business owners pressed for time find it easier to simply run the nanny's salary and taxes through the firm's payroll system rather than setting up a different system for household expenses. "I really believe it's more naïve than malicious," Breedlove says.

So what's left? You could simply take a tax break on your personal returns for child-care expenses. For working parents who make more than $43,000, the maximum Child and Dependent Care Credit is $600 (that's 20% of $6,000 worth of expenses for two or more kids). But generally speaking, if you're making more than $43,000, it's better to set up a company-sponsored dependent-care plan — provided both spouses aren't owners of the company.

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