Paying grandparents for taking care of kids for the summer break - tax implications, paperwork and available deductions

[AnduPandu]

Hello, with the summer break approaching we are thinking of enlisting the help of my wife's parents to look after the kids. The kids are both under 10 and both me and the wife have full time jobs. Grandparents live fairly close by so we can either :

1. Have them come over to our house during the day (household employee scenario)

2. Drop the kids off at their house (independent contractor scenario)

I realize that since they are grand parents, there are some exemptions available to make things easier and that's there where things get muddled from what I have been researching. 

Can someone please detail out the requirements for both parties (us and the grand parents) for withholdings (FICA & Income Tax), documentation to be issued (W-2, 1099-MICs) and any other considerations eg nanny tax.?

Also, how do these requirements change if we decide to claim Child Care tax credit on form 2441 for the money payed to them?

Our first priority is keeping things simple and second priority is saving on taxes. We don't mind forgoing a couple or so hundred dollars in tax savings if it keeps things simple and straightforward for both parties.

[Critter-3]

Well you can keep it simple ... if you pay them less than $30K for the year you can just consider this a gift and no one pays taxes on the income or takes a child care credit which usually offset each other anyway.

Or you could get more complicated ... if they work in your home you need to report the home employees income on a Sch H or provide W-2 forms (like a nanny) and pay the FICA taxes   OR if they work from their home they get to report the SE income on a Sch C and pay SE taxes on the profits.   Taking this route allows you to take the day care credit form 2441 but like I said it will basically be an offset.

[SweetieJean]

 it will basically be an offset.

Except that the grandparents must report the income, but the parents get to take the Child Care Credit.

[Opus 17 · Accepted solution]

Simplest answer: keep it in the family.  They don't report income and you don't claim the credit.

Longer answer: if you want to claim the tax credit, you will have to give the IRS the social security number of the care provider or providers.  The IRS will look for matching income on the provider's return.  If the grandparents are retired on social security, then earning income from work might affect their social security, or it might not be taxable at all, depending on their other sources of income.  It's really too complicated to cover all the "what ifs" in one short answer.

Your responsibilities

If they provide care in your home at your direction, they are household employees and you must issue a W-2 if you pay more than $2300 in a year.  Because they are your parents, you don't have to withhold or pay household employee tax (social security and medicare) on their earnings.  So presumably, if you paid each grandparent $2299, you don't have to do anything.  If you pay more than $2300, you should issue a W-2, there are web sites that will e-file a W-2 and W-3 for you for about $5 each.  

If they provide care in their home, they are independent contractors/self-employed.  You don't issue any paperwork, no 1099 and no W-2.  They are responsible for reporting their own income and expenses on a schedule C.

Their responsibilities

If you provide a W-2, they report the income normally.  If they are household employees but you don't provide a W-2, they still report the income by adding it to their other income and writing "HHS" on the form.  (It might be a different abbreviation, I can never remember the right one and I couldn't find it in 10 seconds of searching online, but Turbotax has a place to enter household employee wages not on a W-2 and will report it properly for them).   If they are self-employed, they report the income on schedule C.  They can deduct expenses, such as the cost of meals and a portion of their household expenses like utilities and insurance.  They pay income tax and self-employment tax on the net profit.  Having taxable income earned from working (earned income) after retirement has a variety of consequences, that are both potentially good and potentially bad, depending on their tax situation.