Can I pay my parents who live with us to babysit my baby using FSA dependent fund?

[MK100]

My parents currently have no income at all, but they do have savings. We don't report them as our dependents as we are not paying half of their living expenses (As I just said, although they don't have income, they have their own savings)

Am I right on the following?

1. Since we are not covering half of their living expenses, we don't need to claim them as our dependents. 

1. They take care our baby at my house, so they are considered as household employees. We don't need to withhold FICA tax and they don't need FICA tax either.

2. Even if we pay them over $2200, we don't need to issue W2. They do plan to report the income on their tax return.

3. For the $5000 we elected to contribute to the FSA dependent account, we are not paying any tax on it. And if my parents do not need to pay any tax (FICA or income tax) on the $5000, then no one is paying any tax on it. Does it make sense? 

[DanaB27]

Correct, if your parents do not meet the requirements to claim them then they are not your dependents.

Correct, for parents you do not need to withhold FICA tax and you do not need to issue a W-2. Please see 2021 Publication 926 pages 5 and 6 for details.

Your parents will still have to report the income on their tax return unless their total income is under the filing threshold. If your parents are required to file a return they will enter the income like this:

1. Login to your TurboTax Account 
2. Click on  “Federal” on the left
3. Scroll down the screen until to come to the section “Less Common Income” and click "Show more"
4. Click "Start" next to  "Miscellaneous Income"
5. Choose "Other Income not already reported on a Form W-2 or Form 1099 " 
6. Select "Yes" for "Other Wages Received"
7. Enter amount "Wages Earned as a Household Employee" screen

Please see this discussion for additional information.

[MK100]

Thank you!  What do you think about my third question "no one is going to pay tax on that $5000, is it reasonable?" 

The reason I was asking was because someone brought up that  issue in another similar grandparents nanny topic. 

That person said " Someone is going to pay tax on that income, either you or your parents". 

In my situation, neither me or my parents need to pay any FICA or income tax on that $5000 we contribute to the FSA dependent account. Would IRS be mad about it?

[DanaB27]

It will be true if your parents standard deduction reduces their taxable income to $0. Then nobody will pay taxes on it in a legal way. Your parents might want to file a return even though they are under the filing threshold so the IRS can match the income and your expenses and see that the income was reported.