There are two possible tax breaks for household employers – if they pay legally.  In most cases, these tax breaks will offset the vast majority of your tax costs; in some cases, the tax breaks will be more than the tax costs, actually saving you money by paying legally.  Here are the two tax breaks:

• Dependent Care Account (also known as "Flexible Spending Account"). Most companies allow families with dependent care expenses to contribute up to $5,000 of their pretax earnings to a Dependent Care Account.  This portion of the compensation is free of all payroll and income taxes, thereby saving between $2,100 - $2,300, depending on tax bracket.
• Tax Credit. For those who don’t have access to a Dependent Care Account, the Tax Credit for Child or Dependent Care (Form 2441) can be claimed on your income tax return at year-end.  The IRS provides a tax credit of 20% on qualifying childcare expenses up to $3,000 for one dependent, or up to $6,000 for two or more dependents. This saves families $600 - $1,200, depending on the number of dependents.

A Real Life Example

A household employer in Maryland pays a caregiver $1,800 per month.  The employer contributes the maximum $5,000 per year to his/her dependent care account at work.  This account provides a tax savings of about $2,300 per year, based on a 45% marginal tax rate.  The employer’s portion of the taxes amounts to about $2,000 per year, so the employer covers the entire tax cost plus $300 simply by paying their employee legally!