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Tax Strategies for Individuals

by Donald Hayden
02 Aug 2024

Retirement Plan Distributions: When To Take Them

When must you start withdrawing the funds in your retirement plans? And what happens if the funds aren’t withdrawn before you die? To what extent will your heirs be taxed? The rules are complex but there are ways the savvy taxpayer can maximize the tax shelter.

The basic rule is that you must begin withdrawing funds – and incurring taxes on these withdrawals – no later than April 1 of the year after you turn 73. This rule exists so that retirement funds will be distributed whether or not spent during what for most people is their retirement years.

Under the SECURE 2.0 Act of 2022, for individuals who reach age 72 after December 31, 2022, and age 73 before January 1, 2033, the applicable age for starting RMDS is 73. For individuals who attain age 74 after December 31, 2032, the applicable age is 75. The new rules apply to distributions required to be made after December 31, 2022, for individuals who attain age 72 after such date. In other words, taxpayers born between 1951 and 1959 will begin RMDs at age 73. Those born in 1960 or later will begin taking RMDs at age 75.

An exception to this general rule is that, where your retirement plan permits, you do not need to begin these mandatory withdrawals until you retire if you are still employed when you reach the mandatory withdrawal age. The exception doesn’t apply where you’re a five percent or more owner of the business that provides the plan, or to withdrawals from traditional IRAs – in those cases, you are subject to the mandatory withdrawal rules.

Related Guide: Roth IRAs are another exception. For a discussion of Roth IRAs, please see the Financial Guide: ROTH IRAS: How They Work And How To Use Them.

Preserving the tax shelter. Your funds grow sheltered from tax while they are in the retirement plan. So the longer your financial situation lets you prolong the distribution or the smaller the amount you must withdraw the more your assets grow. Some taxpayers choose to defer withdrawals for as long as the law allows, to maximize assets and the shelter, for the next generation.

The law has specific rules about how fast the money must be taken out of the plan after your death. These rules curtail the ability to prolong a tax shelter that started out to aid your retirement.The rules are complex, but here’s a general overview of the timing of retirement plan distributions which will help avoid unnecessary tax headaches for you and your heirs. Because of the complexity of the rules, professional guidance in this area is strongly suggested.

Related Guide: The tax treatment will be dictated not only by the timing of the withdrawal (i.e., when to take it) but also by the form of the withdrawal (i.e., how to take it). This Financial Guide discusses the “when.” For a discussion of the “how,” please see the Financial Guide: RETIREMENT PLAN DISTRIBUTIONS: HOW to Take Them.

  • Withdrawal While You’re Alive
  • Withdrawal After You Die
  • Tax Planning
Withdrawal While You’re Alive

Before You Reach Age 73

Until the year you reach 73, you need not take your money out of your retirement account, although your employer’s plan might require you to do so. In fact, there will usually be a 10 percent early-withdrawal penalty if you make withdrawals from an IRA before age 59 1/2. Between the ages of 59 1/2 and 73; you pay only the income tax on any amounts you decide to withdraw, with no tax on the return of after-tax contributions you made.

Taxpayers affected by the coronavirus were able to withdraw up to $100,000 and will not be subject to the 10 percent penalty for early withdrawals. Distributions must have been taken before December 31, 2020. The amount withdrawn is considered income, however, and taxpayers have three years to pay the tax on the additional income and replace the funds in-kind.

Once You Reach Age 73

Once you hit 73, withdrawals must begin. Technically they can be postponed until April 1 of the year following the year you reach 73, but waiting until April 1 of the following year means you must withdraw for two years. To avoid this income bunching and a possible higher marginal tax rate, tax advisers generally suggest withdrawing in the year you reach 73.

IRS has greatly simplified and relaxed the withdrawal rules over the years to increase the retirement plan tax shelter, by lengthening, in most cases, the period over which plan withdrawals may be stretched.

The rules allow you, automatically, to spread your withdrawals over a period substantially longer than your life expectancy. Under these rules the taxpayer (say, an IRA owner) first determines his or her retirement plan asset values as of the end of the preceding year. Then the owner takes the number for his or her age from an IRS table (the table is unisex). The number corresponds to the period over which the withdrawals may be spread. The owner divides that number into the retirement asset total. The result is the amount to be withdrawn for the year.

Example 1: Joe reaches age 73 in October of this year. Retirement plan assets in his IRA totaled $600,000 at the end of last year. The IRS number for age 73 is 26.5. Joe must withdraw $22,641 ($600,000/26.5) this year.

The distribution period in the IRS table in effect assumes distribution over a period based on your life expectancy plus that of a beneficiary 10 years younger than you. Distribution after your death is based on the actual life span or life expectancy of your actual beneficiary (see “Withdrawal after You Die” below). Only where your designated beneficiary is a spouse more than 10 years younger than you is his or her actual life expectancy used to figure the withdrawal period during your lifetime. You may use these rules to prolong distribution for 2003 and after, even though you have been taking withdrawals over a shorter period under previous rules.

Under the current rules, the life expectancy of your designated beneficiary (if you have one) is irrelevant in figuring your withdrawal period (except for a beneficiary spouse more than 10 years younger). Thus, you can change your designated beneficiary at will, or replace one who died, without affecting your withdrawal period (except for a change to or from a spouse more than 10 years younger).

You can always take out money faster than required and pay tax on these withdrawals; however, the tax code is strict about minimum withdrawals. If you or your beneficiaries or heirs fail to take out what’s required, a tax penalty will take 50 percent of what should have been withdrawn but wasn’t.

Withdrawal After You Die

The rules as to how fast your beneficiaries or heirs must withdraw funds from your account and pay the income tax-differ, depending on your beneficiary choice.

Under the SECURE Act of 2019, and starting in 2020, there is a new beneficiary category – the eligible designated beneficiary (EDB). An EDB can include the IRA owner’s surviving spouse or minor child, a person who is chronically ill or disabled, or another individual (e.g., parent, sibling, and unmarried partner) who is not more than 10 years younger than the IRA owner at the time of his/her death. If an individual inherits an IRA in 2020 (or in years beyond) but does not meet the definition of an EDB they may be required to take full distribution of the inherited IRA within 10 years after the IRA owner’s year of death.

Of course, designating a beneficiary is wise as a matter of planning for the disposition of your assets. You may change the beneficiary later without affecting the amount you withdraw (except for a change to or from a spouse more than 10 years younger).

Eligible Designated Beneficiaries: Your Spouse. Naming your spouse as beneficiary carries the most flexibility. A surviving spouse has options that no other beneficiary has such as:

  • Leave the money in the IRA account. If your spouse, for example, is the sole beneficiary, he or she may elect to treat the balance in the IRA as if it were their own. Depending on their age, they may be required to take required minimum distributions.
  • Rollover to another IRA. A spouse beneficiary of your IRA can elect to roll the IRA balance over to their own IRA. This provides the optimal extension of the withdrawal period if your spouse is younger than you since your spouse doesn’t have to start withdrawing funds until they turn 73. At age 73, your spouse can then use the period in the IRS table or a longer one if they then has a spouse more than 10 years younger. A rollover isn’t allowed if a trust is a beneficiary, even if the spouse is the trust’s sole beneficiary. A similar extension is allowed for a balance you might leave in a qualified retirement plan: your spouse can roll it over into his or her IRA. And your spouse can roll over a distribution from your retirement plan to another retirement plan in which he or she participates, as well as to an IRA.
  • Remaining a beneficiary. Instead of a rollover, a surviving spouse can simply leave the money in the deceased participant’s account. There’s no 10 percent early-withdrawal penalty if the spouse takes funds out of your account, but that penalty would apply if the spouse rolled over the money into his or her own IRA and tapped it before reaching 59 1/2.

Leaving the money in your account makes sense if your spouse is under age 59 1/ 2 and needs the money soon after your death. If your spouse remains a beneficiary, he or she doesn’t have to start withdrawals until you would have reached age 73 after which withdrawals will be taken under the IRS table. Generally, there will not be an estate tax on retirement plan assets left to a spouse and the spouse will pay income taxes only as funds are withdrawn.

Eligible Designated Beneficiaries: Your Minor Child. If you name your child you should be aware that upon reaching the age of majority (18 in most states, 19 in Alabama and Nebraska, and 21 in Mississippi) your child will become a non-eligible designated beneficiary and subject to the 10-year rule – i.e., required to take full distribution of the inherited IRA within 10 years.

Non-Designated Beneficiaries. This type of beneficiary does not have a life expectancy. As such, distributions are different depending on whether the IRA account owner dies before, during, or after the start of the required beginning date for required minimum distributions (RMDs). If a traditional IRA owner passes away after his/her RBD, the beneficiary must continue distributions using the decedent’s life expectancy. If before, then the entire account balance must be taken by the end of 5th year following year of death. Beneficiaries of Roth IRA account owners who have died must distribute the assets within five years.

The required payout schedules set the minimum that can be withdrawn. The beneficiary can always take out more.

No beneficiary. If you die before April 1 after the year you reach age 73 having named no beneficiary or, in most cases, where your beneficiary is not a human being (such as an estate or a charity), all funds must be distributed and income taxes paid within five to six years of your death. Heirs don’t get the option of using their own life expectancy.

If you die on or after that April 1 date without having named a beneficiary or having named your estate as the beneficiary, the money must come out by the end of the period remaining under the IRS table. For example, at age 80 the table period is 20.2. On a death at age 80, the estate or heirs would have 20.2 years to complete withdrawal.

Death before distributions begin. If you should die before the time (age 73) required distributions are to begin, minimum distributions to your beneficiary can be spread over his or her life expectancy.

Estate tax. There may be an estate tax on retirement funds left to someone other than your spouse, who will also owe an income tax as funds are withdrawn. Where an estate tax is imposed, the taxpayer who received the retirement funds is entitled to a partial income tax deduction for the estate tax paid.

Tax Planning

The above discussion covered the general rules as to the withdrawal of retirement plan distributions both before and after you die. Now let’s look at some specific tax planning techniques, particularly as regards the estate tax, for minimizing the tax bite when the funds accumulated in your retirement accounts (including pension and profit-sharing plans, 401(k) plans, IRAs and rollover IRAs) are passed on to your heirs.

How Your Heirs Are Taxed

The general rule is that, while there may be a estate tax bite at your death, inherited assets are received income-tax-free by your heirs. Unfortunately, however, this general rule doesn’t apply to money in a retirement plan. Whoever gets the money will incur income tax on it, unless it’s left to charity (more on giving retirement assets to charity below).

If you gave your wife a $500,000 stock-and-bond portfolio, she will not pay income tax on receipt of the portfolio. Or if you leave your son a $150,000 vacation home, he will not pay income tax when he receives it. But if you leave your daughter the $150,000 in your IRA, she will be subject to income tax on it, more or less as you would be if you had received the distributions yourself. (Moreover, there may be a further estate tax as well.)

The basic income tax rule is that retirement plan distributions to heirs are taxable at ordinary rates, except for after-tax investments, which come out tax-free. There are, however, the following key exceptions or qualifications:

  • On a lump sum distribution, heirs of persons born before 1936 can sometimes claim tax relief.
  • Life insurance proceeds paid in a lump sum are tax-exempt. However, if they are paid in installments, the interest element is taxable.
  • The value of a stock bonus is taxable when received as ordinary income, less unrealized appreciation, and after-tax investment. Any appreciation is taxable as capital gain when the stock is sold.
  • Your spouse can roll over from your retirement account (IRA or other) to his or her IRA. No other heir can roll over from your account.
  • There’s no early withdrawal penalty on what your heir withdraws after your death, even if the heir is under age 59½, but in general, if your spouse is your heir and rolls over your retirement account to his or her IRA, a withdrawal from the IRA while under age 59 1/2 is subject to the penalty.

Some Tax Planning Opportunities

The federal estate tax isn’t a major problem for most Americans. Less than one percent of those who die in any year leave an estate that’s hit by the estate tax; but the larger a taxpayer’s retirement account, the more likely it will be cut down by the federal estate tax on top of the federal income tax described above.

Unlike the income tax, which is collected only as amounts are distributed – and thus is deferred on annuities and the like – the estate tax is collected up front, at the owner’s death, on the present value of the annuity.

One common planning technique – making lifetime gifts to reduce your taxable estate is impractical for retirement accounts. Even where you might be able to give part of your retirement account away (as with an IRA, for example), your gift is a taxable distribution to you and no IRA tax shelter survives for your donee. But there are more practical techniques:

  • Make your spouse the beneficiary of your retirement plan assets and leave non-retirement plan assets to non-spouse beneficiaries. This reduces estate taxes and permits deferral of income taxes for the longest period possible.
  • If you plan on leaving assets to charity, use retirement plan assets. You can eliminate estate and income taxes on this amount while achieving charitable goals.
  • A charitable remainder trust is a sophisticated way to benefit family, as well as charity at a reduced tax cost. Typically, your children or other non-spouse beneficiaries will draw the income from the retirement assets for a period, after which the remainder goes to charity. An estate tax deduction is allowed for the present value of what will go to the charity.
  • Consider buying life insurance to pay estate tax that can’t be avoided (perhaps because you want a large retirement account to go to someone other than a spouse or charity). The insurance proceeds will be exempt from income tax (while funds withdrawn from the account to pay estate tax will be subject to income tax). With proper planning, the withdrawn funds can escape estate tax as well.

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by Donald Hayden
02 Aug 2024

Annuities: How They Work and When You Should Use Them

Annuities may help you meet some of your mid and long-range goals such as planning for your retirement and for a child’s college education. This Financial Guide tells you how annuities work, discusses the various types of annuities, and helps you determine which annuity product (if any) suits your situation. It also discusses the tax aspects of annuities and explains how to shop for both an insurance company and an annuity, once you know which type you’ll need.

  • How Annuities Work
  • How Annuities Best Serve Investors
  • Types Of Annuities
  • Choosing A Payout Option
  • How Payouts Are Taxed
  • How To Shop For An Annuity
  • Costs, Penalties, And Extras
  • Risk To Retirees of Using An Immediate Annuity
How Annuities Work

While traditional life insurance guards against “dying too soon,” an annuity, in essence, can be used as insurance against “living too long.” In brief, when you buy an annuity (generally from an insurance company, that invests your funds), you in turn receive a series of periodic payments that are guaranteed as to amount and payment period. Thus, if you choose to take the annuity payments over your lifetime (keep in mind that there are many other options), you will have a guaranteed source of “income” until your death. If you “die too soon” (that is, you don’t outlive your life expectancy), you will get back from the insurer far less than you paid in. On the other hand, if you “live too long” (and do outlive your life expectancy), you may get back far more than the cost of your annuity (and the resultant earnings). By comparison, if you put your funds into a traditional investment, you may run out of funds before your death.

The earnings that occur during the term of the annuity are tax-deferred. You are not taxed on them until they are paid out. Because of the tax deferral, your funds have the chance to grow more quickly than they would in a taxable investment.

How Annuities Best Serve Investors

Assess the costs of an annuity relative to the alternatives. Separate purchase of life insurance and tax-deferred investments may be more cost effective.

The two primary reasons to use an annuity as an investment vehicle are:

  1. You want to save money for a long-range goal, and/or
  2. You want a guaranteed stream of income for a certain period of time.

Annuities lend themselves particularly well to funding retirement and, in certain cases, education costs.

One negative aspect of an annuity is that you cannot get to your money during the growth period without incurring taxes and penalties. The tax code imposes a 10 percent premature-withdrawal penalty on money taken out of a tax-deferred annuity before age 59½, and insurers impose penalties on withdrawals made before the term of the annuity is up. The insurers’ penalties are termed “surrender charges,” and they usually apply for the first seven years of the annuity contract.

These penalties lead to a de facto restriction on the use of annuities primarily as an investment. It only makes sense to put your money into an annuity if you can leave it there for at least ten years and the withdrawals are scheduled to occur after age 59½. These restrictions explain why annuities work well for either retirement needs or for cases of education funding where the depositor will be at least 59½ when withdrawals begin.

The greater the investment return, the less punishing the 10 percent penalty on withdrawal under age 59½ will appear. If your variable annuity investments have grown substantially, you may want to consider taking some of those profits (despite the penalty, which applies only to the taxable portion of the amount withdrawn).

Annuities can also be effective in funding education costs where the annuity is held in the child’s name under the provisions of the Uniform Gifts to Minors Act. The child would then pay tax (and 10 percent penalty) on the earnings when the time came for withdrawals.

A major drawback is that the child is free to use the money for any purpose, not just education costs.

Types Of Annuities

The available annuity products vary in terms of (1) how money is paid into the annuity contract, (2) how money is withdrawn, and (3) how the funds are invested. Here is a rundown on some of the annuity products you can buy:

Single-Premium Annuities. You can purchase a single-premium annuity, in which the investment is made all at once (perhaps using a lump sum from a retirement plan payout). The minimum investment is usually $5,000 or $10,000.

Flexible-Premium Annuities. With the flexible-premium annuity, the annuity is funded with a series of payments. The first payment can be quite small.

Immediate Annuities. The immediate annuity starts payments right after the annuity is funded. It is usually funded with a single premium and is usually purchased by retirees with funds they have accumulated for retirement.

Deferred Annuities. With a deferred annuity, payouts begin many years after the annuity contract is issued. You can choose to take the scheduled payments either in a lump sum or as an annuity, that is, as regular annuity payments over some guaranteed period. Deferred annuities are used as long-term investment vehicles by retirees and non-retirees alike. They are used to fund tax-deferred retirement plans and tax-sheltered annuities. They may be funded with a single or flexible premium.

Fixed Annuities. With a fixed annuity contract, the insurance company puts your funds into conservative fixed income investments such as bonds. Your principal is guaranteed and the insurance company gives you an interest rate that is guaranteed for a certain minimum period from a month to several years. This guaranteed interest rate is adjusted upwards or downwards at the end of the guarantee period. Thus, the fixed annuity contract is similar to a CD or a money market fund, depending on the length of the period during which interest is guaranteed. The fixed annuity is considered a low-risk investment vehicle. All fixed annuities also guarantee you a certain minimum rate of interest of 3 to 5 percent for the entirety of the contract. The fixed annuity is a good choice for investors with a low-risk tolerance and a short-term investing time horizon. The growth that will occur will be relatively low. Fixed annuity investors benefit if interest rates fall, but not if they rise.

Variable Annuities. The variable annuity, which is considered to carry with it higher risks than the fixed annuity – about the same risk level as a mutual fund investment – gives you the ability to choose how to allocate your money among several different managed funds. There are usually three types of funds: stocks, bonds, and cash-equivalents. Unlike the fixed annuity, there are no guarantees of principal or interest. However, the variable annuity does benefit from tax deferral on the earnings.

You can switch your allocations from time to time for a small fee or sometimes for free.

The variable annuity is a good annuity choice for investors with a moderate to high-risk tolerance and a long-term investing time horizon. Variable annuities have higher costs than similar investments that are not issued by an insurance company.

The taxable portion of variable annuity distributions is taxable at full ordinary rates, even if they are based on stock investments. Unlike dividends from stock investments (including mutual funds), there is no capital gains relief.

Annuities are available that combine both fixed and variable features. Before buying an annuity, contribute as much as possible to other tax-deferred options such as IRA’s and 401 (k) plans. The reason is that the fees for these plans are likely to be lower than those of an annuity and early-withdrawal fees on annuities tend to be steep.

IRA contributions are sometimes invested in flexible premium annuities with IRA deduction, if otherwise available. You may prefer to use IRAs for non-annuity assets. Non-annuity assets gain the ability to grow tax-free when held in an IRA. The IRA regime adds no such benefit to annuity assets which grow tax-free in or outside IRAs.

Choosing A Payout Option

When it’s time to begin taking withdrawals from your deferred annuity, you have a number of choices. Most people choose a monthly annuity-type payment, although a lump sum withdrawal is also possible.

Once you have chosen a payment option, you cannot change your mind.

The size of your payout (settlement option) depends on:

  1. The size of the amount in your annuity contract
  2. Whether there are minimum required payments
  3. Your life expectancy (or other payout period)
  4. Whether payments continue after your death

Here are summaries of the most common forms of payout:

Fixed Amount

This type gives you a fixed monthly amount (chosen by you) that continues until your annuity is used up. The risk of using this option is that you may live longer than your money lasts. Thus, if the annuity is your only source of income, the fixed amount is not a good choice. And, if you die before your annuity is exhausted, your beneficiary gets the rest.

Fixed Period

This option pays you a fixed amount over the time period you choose. For example, you might choose to have the annuity paid out over ten years. If you are seeking retirement income before some other benefits start, this may be a good option. If you die before the period is up, your beneficiary gets the remaining amount.

Lifetime or Straight Life

This type of payment continues until you die. There are no payments to survivors. The life annuity gives you the highest monthly benefit of the options listed here. The risk is that you will die early, thus leaving the insurance company with some of your funds. The life annuity is a good choice if (1) you do not need the annuity funds to provide for the needs of a beneficiary and (2) you want to maximize your monthly income.

Life With Period Certain

This form of payment gives you payments as long as you live (as does the life annuity) but with a minimum period during which you or your beneficiary will receive payments, even if you die earlier than expected. The longer the guarantee period, the lower the monthly benefit.

Installment-Refund

This option pays you as long as you live and guarantees that, should you die early, whatever is left of your original investment will be paid to a beneficiary. Monthly payments are less than with a straight life annuity.

Joint And Survivor

In one joint and survivor option, monthly payments are made during the annuitants’ joint lives, with the same or a lesser amount paid to whoever is the survivor. In the option typically used for retired employees (employment model), monthly payments are made to the retired employee, with the same or a lesser amount to the employee’s surviving spouse or another beneficiary. The difference is that with the employment model, the spouse’s (or other co annuitant’s) death before the employee won’t affect what the survivor employee collects. The amount of the monthly payments depends on the annuitants’ ages, and whether the survivor’s payment is to be 100 percent of the joint amount or some lesser percentage.

How Payouts Are Taxed

The way your payouts are taxed differs for qualified and non-qualified annuities.

Qualified Annuity

A tax-qualified annuity is one used to fund a qualified retirement plan, such as an IRA, Keogh plan, 401(k) plan, SEP (simplified employee pension), or some other retirement plan. The tax-qualified annuity, when used as a retirement savings vehicle, is entitled to all of the tax benefits (and penalties) that Congress saw fit to attach to such qualified plans.

The tax benefits are:

  1. Any nondeductible or after-tax amount you put into the plan is not subject to income tax when withdrawn
  2. The earnings on your investment are not taxed until withdrawal

If you withdraw money from a qualified plan annuity before the age of 59 1/2, you will have to pay a 10 percent penalty on the amount withdrawn in addition to paying the regular income tax. There are exceptions to the 10 percent penalty, including an exception for taking the annuity out in a series of equal periodic payments over the rest of your life.

For individuals who reached age 72 after December 31, 2022, and age 73 before January 1, 2033, the applicable age for starting RMDS is 73. Roth IRAs and employees still in the workforce after age 73 are exempted. For individuals who attain age 74 after December 31, 2032, the applicable age is 75. The new rules apply to distributions required after December 31, 2022, for individuals who attain age 72 after such date. In other words, taxpayers born between 1951 and 1959 will begin RMDs at age 73. Those born in 1960 or later will begin taking RMDs at age 75. [SECURE Act 2.0 of 2022]

Non-Qualified Annuity

A non-qualified annuity is purchased with after-tax dollars. You still get the benefit of tax deferral on the earnings; however, you pay tax on the part of the withdrawals that represent earnings on your original investment.

If you make a withdrawal before the age of 59 1/2, you will pay the 10 percent penalty only on the portion of the withdrawal that represents earnings.

With a non-qualified annuity, you are not subject to the minimum distribution rules that apply to qualified plans after you reach age 73 in tax years 2023 to 2033.

Tax on Your Beneficiaries or Heirs

If your annuity is to continue after your death, other taxes may apply to your beneficiary (the person you designate to take further payments) or your heirs (your estate or those who take through the estate if you didn’t designate a beneficiary).

Income Tax. Annuity payments collected by your beneficiaries or heirs are subject to tax on the same principles that would apply to payments collected by you.

Exception. There’s no 10 percent penalty on withdrawal under age 59 1/2; regardless of the recipient’s age, or your age at death.

Estate Tax. The present value at your death of the remaining annuity payments is an asset of your estate, and subject to estate tax with other estate assets. Annuities passing to your surviving spouse or to charity would escape this tax.

If a particular fund has a great track record, ascertain whether the same management is still in place. Although past performance is no guarantee, consistent management will grant you better odds.

How To Shop For An Annuity

Although annuities are typically issued by insurance companies, they may also be purchased through banks, insurance agents, or stockbrokers.

There is considerable variation in the amount of fees that you will pay for a given annuity as well in the quality of the product. Thus, it is important to compare costs and quality before buying an annuity.

First, Check Out The Insurer

Before checking out the product itself, it is important to make sure that the insurance company offering it is financially sound. Because annuity investments are not federally guaranteed, the soundness of the insurance company is the only assurance you can rely on. Consult services such as A.M. Best Company, Moody’s Investor Service, or S&P Global’s Ratings to find out how the insurer is rated.

Next, Compare Contracts

The way you should go about comparing annuity contracts varies with the type of annuity:

Immediate Annuities: Compare the settlement options. For each $1,000 invested, how much of a monthly payout will you get? Be sure to consider the interest rate and any penalties and charges.

Deferred Annuities: Compare the rate, the length of guarantee period, and a five-year history of rates paid on the contract. It is important to consider all three of these factors and not to be swayed by high interest rates alone.

Variable Annuities: Check out the past performance of the funds involved.

If a particular fund has a great track record, ascertain whether the same management is still in place. Although past performance is no guarantee, consistent management will grant you better odds.

Costs, Penalties, And Extras

Be sure to compare the following points when considering an annuity contract:

Surrender Penalties

Find out the surrender charges (that is, the amounts charged for early withdrawals). The typical charge is seven percent for first-year withdrawals, six percent for the second year, and so on, with no charges after the seventh year. Charges that go beyond seven years, or that exceed the above amounts, should not be acceptable.

Be sure the surrender charge “clock” starts running with the date your contract begins, not with each new investment.

Fees And Costs

Be sure to ask about all other fees. With variable annuities, the fees must be disclosed in the prospectus. Fees lower your return, so it is important to know about them. Fees might include:

  • Mortality fees of 1 to 1.35 percent of your account (protection for the insurer in case you live a long time)
  • Maintenance fees of $20 to $30 per year
  • Investment advisory fees of 0.3 percent to 1 percent of the assets in the annuity’s portfolios.

Extras

These provisions are not costs per se, but should be asked about before you invest in the contract. Some annuity contracts offer “bail-out” provisions that allow you to cash in the annuity if interest rates fall below a stated amount without paying surrender charges.

There may also be a “persistency” bonus which rewards annuitants who keep their annuities for a certain minimum length of time. In deciding whether to use annuities in your retirement planning (or for any other reason) and which types of annuities to use, professional guidance is advisable.

Risk To Retirees of Using An Immediate Annuity

At first glance, the immediate annuity would seem to make sense for retirees with lump-sum distributions from retirement plans. After all, an initial lump-sum premium can be converted into a series of monthly, quarterly, or yearly payments that represent a portion of principal plus interest and is guaranteed to last for life. The portion of the periodic payout that constitutes a return of principal is excluded from taxable income.

However, this strategy contains risks. For one thing, when you lock yourself into a lifetime of level payments, you fail to guard against inflation. Furthermore, you are gambling that you will live long enough to get your money back. Thus, if you buy a $150,000 annuity and die after collecting only $60,000, the insurer often gets to keep the rest. Unlike other investments, the balance doesn’t go to your heirs. Finally, since the interest rate is fixed by the insurer when you buy it, you may be locking yourself into low rates.

You can hedge your bets by opting for a “period certain,” or “term certain” which, in the event of your death, guarantees payment for some years to your beneficiaries. There are also “joint-and-survivor” options (which pay your spouse for the remainder of his or her life after you die) or a “refund” feature (in which some or all of the remaining principal is resumed to your beneficiaries).

Some plans offer quasi-inflation adjusted payments. One company offers a guaranteed increase in payments of $10 at three-year intervals for the first 15 years. Payments then get an annual cost-of-living adjustment with a three percent maximum. However, for these enhancements to apply, you will have to settle for much lower monthly payments than the simple version.

Recently, a few companies have introduced immediate annuities that offer potentially higher returns in return for some market risk. These “variable immediate annuities” convert an initial premium into a lifetime income; however, they tie the monthly payments to the returns on a basket of mutual funds.

Seniors 75 years of age and older may have fewer worries about inflation or liquidity. Nevertheless, they should question whether they really need such annuities at all.

If you want a comfortable retirement income, consider a balanced portfolio of mutual funds. If you want to guarantee that you will not outlive your money, you can plan your withdrawals over a longer time horizon.

CONTINUE READING
by Donald Hayden
02 Aug 2024

Higher Education Costs: How To Get The Best Tax Treatment

Various tax benefits, including tax exemption, tax deferral, tax credits, and deductions, are available if you are paying or saving for college or other higher education costs. This Guide suggests ways to take advantage of these benefits.

Many tax benefits are available to help you pay higher education costs, whether for your children or yourself. Because of the variety of benefits and programs, this area is one of the most complex that an individual can face. This Financial Guide discusses strategies you can use to build savings for higher education, and tax credits currently available to help ease the financial burden of paying for education.

Eligibility rules vary for education credits and savings plans and most are subject to income limitations.

Related Financial Guide: For more information about saving and investing to cover education costs, please see the Financial Guide: YOUR CHILD’S EDUCATION: How To Finance It.

  • Coverdell Education Savings Accounts (Section 530 Programs)
  • Qualified Tuition Programs (Section 529 Programs)
  • Traditional and Roth IRAs
  • Education Savings Bonds
  • Education Credits
  • Qualified Tuition and Related Expenses Deduction
  • Employer-Provided Education Assistance
  • Student Loans
Coverdell Education Savings Accounts (Section 530 Programs)

Starting in 2013, you can contribute up to $2,000 to a Coverdell Education Savings account (a Section 530 program formerly known as an Education IRA) for a child under 18. These contributions are not deductible, but they grow tax-free until withdrawn. Contributions for any year can be made through the (unextended) due date for the return for that year.

There is no adjustment for inflation; therefore the $2,000 contribution limit is expected to remain at $2,000 for tax years 2012 and beyond.

Only cash can be contributed to a Section 530 account and you cannot contribute to the account after the child reaches his or her 18th birthday.

Anyone can establish and contribute to a Section 530 account, including the child. You may establish 530s for as many children as you wish, but the amount contributed during the year to each account cannot exceed $2,000. The child need not be a dependent, and, in fact, does not even need to be related to you. The maximum contribution amount for each child is subject to a phase-out limitation with a modified AGI between $190,000 and $220,000 for joint filers and $95,000 and $110,000 for single filers.

A 6 percent excise tax (to be paid by the beneficiary) applies to excess contributions. These are amounts in excess of the applicable contribution limit ($2,000 or phase out amount) and contributions for a year that amounts are contributed to a qualified tuition program for the same child. A qualified tuition program (QTP), sometimes called a Section 529 program, is a tax-favored state program to prepay education costs (see below). The 6 percent tax continues for each year the excess contribution stays in the 530 account.

The child must be named (designated as beneficiary) in the Coverdell document, but the beneficiary can be changed to another family member (for example, to a sibling where the first beneficiary gets a scholarship or drops out). And funds can be rolled over tax-free from one child’s account to another child’s account. Funds must be distributed not later than 30 days after the beneficiary’s 30th birthday (or 20 days after the beneficiary’s death if earlier). For special needs beneficiaries, age limits (i.e., no contributions after age 18, distribution by age 30) don’t apply.

Withdrawals are taxable to the person who gets the money, with these major exceptions: Only the earnings portion is taxable (the contributions come back tax-free). Also, even that part isn’t taxable income, as long as the amount withdrawn doesn’t exceed a child’s qualified higher education expenses; for that year. The definition of qualified higher education expenses” includes room and board and books, as well as tuition. In figuring whether withdrawals exceed qualified expenses, expenses are reduced by certain scholarships and by amounts for which tax credits (see Educational Credits, below) are allowed. If the amount withdrawn for the year exceeds the education expenses for the year, the excess is partly taxable under a complex formula. There’s another formula if the sum of withdrawals from this 530 program and from the qualified tuition (Section 529) program exceed education expenses.

As the person who sets up the Section 530 account, you may change the beneficiary (the child who will get the funds) or roll the funds over to the account of a new beneficiary, tax-free, if the new beneficiary is a member of your family. But funds you take back (for example, withdrawal in a year when there are no qualified higher education expenses, because the child is not enrolled in higher education) are taxable to you, to the extent of earnings on your contributions, and you will generally have to pay an additional 10 percent tax on the taxable amount. However, you won’t owe tax on earnings on amounts contributed that are returned to you by June 1 of the year following contribution.

Investment Policy

In contrast to Section 529 programs and Series EE bonds, you are able to choose and change Section 530 investments as you see fit.

Check with your financial adviser about using both the Section 530 program, which has wide investment options but limited ($2,000 or less) contribution/investment amounts, and the Section 529 program, which has limited investment options but allows higher contribution/investment amounts.

Elementary and Secondary Schools

Section 530 programs can be used to build up funds for primary and secondary education. The tax rules are similar to those for higher education: withdrawals taxable to the extent of earnings on contributions, except tax-free up to the child’s qualified elementary and secondary education expenses. These expenses qualify whether the child attends a private, religious or public school. Expenses such as room, board, tuition, transportation, and uniforms will qualify only where connected with private or religious schools, but some expenses – books, computers, educational software and internet access – apply as well to children in public school living at home.

The age limits for higher education apply here too: no contribution after a child reaches age 18, distribution at age 30 except for special needs beneficiaries. Withdrawals in excess of qualified education expenses are taxable under a special formula.

Qualified Tuition Programs (Section 529 Programs)

Every state now has a program allowing persons to prepay for future higher education, with tax relief. Starting in 2018, funds in 529 Plans can also be used for K-12 education.

There are two basic plan types, with many variations among them:

  1. The prepaid education arrangement. Here one is essentially buying future education at today’s costs, by buying education credits or certificates. This is the older type of program and tends to limit the student’s choice to schools within the state. Private colleges and universities may now offer this type.
  2. Education savings accounts. Here, contributions are made to an account to be used for future higher education.

In approaching state programs one must distinguish between what the federal tax law allows and what an individual state’s program may impose.

You may open a Section 529 program in any state, but when buying prepaid tuition credits (less popular than savings accounts), you will want to know which institutions the credits will be applied to.

Unlike certain other tax-favored higher education programs, such as the American Opportunity Tax Credit and the Lifetime Learning Credit, federal tax law doesn’t limit the benefit to tuition, but can also extend it to room, board, and books (individual state programs could be narrower).

The two key individual parties to the program are the Designated Beneficiary (the student-to-be) and the Account Owner, who is entitled to choose and change the beneficiary and who is normally the principal contributor to the program. There are no income limits on who may be an account owner. There’s only one designated beneficiary per account. Thus, a parent with three college-bound children might set up 3 accounts. (Some state programs don’t allow the same person to be both beneficiary and account owner.)

Contributions must be in cash, and must not total more than reasonably needed for higher education (as determined initially by the state). Neither account owner or beneficiary may direct investments, but the state may allow the owner to select a type of investment fund (e.g., fixed income securities), and to change the investment annually, and when the beneficiary is changed. The account owner decides who gets the funds (can pick and change the beneficiary) and is legally allowed to withdraw funds at any time, subject to tax and penalty discussed later.

Funds in the account not yet distributed at the account owner’s death pass as part of the probate estate under state law though this is not the result for federal estate tax purposes, see below.

Federal Tax Rules

Income tax. Contributions made by the account owner or other contributor are not deductible for federal income tax purposes. Earnings on contributions grow tax-free while in the program.

Distributions from the fund are tax-free to the extent used for qualified higher education expenses. Distributions used otherwise are taxable to the extent of the portion which represents earnings.

A Section 529 distribution can be tax-free even though the student is claiming an American Opportunity Tax Credit or the Lifetime Learning Credit. Section 530 Coverdell distributions are also tax-free if the programs aren’t covering the same specific expenses.

Distribution for a purpose other than qualified education is taxed to the one getting the distribution. In addition, a 10 percent penalty must be imposed on the taxable portion of the distribution, comparable to the 10 percent penalty in Section 530 Coverdell plans.

The account owner may change the beneficiary designation from one to another in the same family. Funds in the account roll over tax-free for the benefit of the new beneficiary.

Gift Tax. For gift tax purposes, contributions are treated as completed gifts even though the account owner has the right to withdraw them. Thus, they qualify for the up-to-$16,000 annual gift tax exclusion in 2022 ($15,000 in 2021). One contributing more than $16,000 may elect to treat the gift as made in equal installments over the year of the gift and the following four years so that up to $80,000 can be given tax-free in the first year.

A rollover from one beneficiary to another in a younger generation is treated as a gift from the first beneficiary, an odd result for an act the “giver” may have had nothing to do with.

Estate tax. Funds in the account at the designated beneficiary’s death are included in the beneficiary’s estate, another odd result, since those funds may not be available to pay the tax. Funds in the account at the account owner’s death are not included in the owner’s estate, except for a portion thereof where the gift tax exclusion installment election is made for gifts over $15,000. For example, if the account owner made the election for a gift of $80,000 in 2022, a part of that gift is included in the estate if he or she dies within five years.

A Section 529 program can be an especially attractive estate-planning move for grandparents. There are no income limits, the account owner giving up to $80,000 avoids gift tax, and estate tax by living five years after the gift, yet has the power to change the beneficiary.

State Tax: For specifics of each state’s program, see College Savings Plans Network (CSPN).

Traditional and Roth IRAs

You can use a traditional IRA or Roth IRA as a savings plan to pay qualified higher education expenses. Withdrawals before age 59 1/2 to pay qualified higher education expenses are not subject to the additional tax on early withdrawals. To escape the 10 percent tax, however, you must pay education costs that at least equal your withdrawal amount. The education costs must be “qualified”, that is, used for tuition, fees, books, room and board, supplies, or equipment at a qualified institution of learning and they must be for yourself, your spouse, or the children or grandchildren or yourself or your spouse. The qualified institution of learning may be any college, university, vocational school, or any other post-secondary school that is eligible to participate in federal Department of Education aid programs.

You do not actually have to use the IRA funds to pay education costs. That is, the tax relief doesn’t require you to trace the IRA withdrawal dollars to a specific education expense payment. You can pay the costs with your own earnings or savings, with a loan, or with a gift or inheritance received by the student or the person making the withdrawal. You can use savings accumulated in a Section 529 (state-sponsored) program.

However, you cannot count education costs paid with proceeds from the following in determining whether your IRA withdrawal is to be free of the 10 percent tax:

  • Tax-free distributions from a Coverdell education savings account (Section 530 program);
  • Tax-free scholarships, such as a Pell grant;
  • Tax-free employer education assistance program;
  • Any tax-free payment (other than a gift or bequest) that is due to enrollment at the qualified institution.

Education Savings Bonds

You can exclude from your gross income interest on qualified U.S. savings bonds if you have qualified higher education expenses during the year in which you redeem the bonds. For tax year 2022, the exclusion begins phasing out at $85,800 ($83,200 in 2021) modified adjusted gross income ($76,000 indexed for inflation) and is eliminated for adjusted gross incomes of more than $100,800 ($98,200 in 2021). For married taxpayers filing jointly, the tax exclusion begins phasing out at $128,650 ($124,800 in 2021) and is eliminated for adjusted gross incomes of more than $158,650 ($154,800 in 2021). The exclusion is unavailable to married filing separately.

The education must be of the bondholder, his or her spouse or dependent. Qualified higher education expenses are tuition and fees, and contributions to Section 529 and 530 programs, reduced for tax-free scholarships and other relief.

A qualified U.S. savings bond means a Series EE bond issued after 1989. The bond must be either in your name or in the names of both you and your spouse, and you must be at least 24 years old before the bond’s issue date.

Education Credits

Two tax credits are available for education costs – the American Opportunity Tax Credit and the Lifetime Learning Credit. These credits are available only to taxpayers with adjusted gross income below specified amounts (see Income Phase-Outs below).

How These Credits Work

The amount of the credit you can claim depends on (1) how much you pay for qualified tuition and other expenses for students and (2) your adjusted gross income (AGI) for the year.

You must report the eligible student’s name and Social Security number on your return to claim the credit. You subtract the credits from your federal income tax. If the credit reduces your tax below zero, you cannot receive the excess as a refund. If you receive a refund of education costs for which you claimed a credit in a later year, you may have to repay (“recapture”) the credit.

If you file married-filing separately, you cannot claim these credits.

Which costs are eligible? Qualifying tuition and related expenses refer to tuition and fees, and course materials required for enrollment or attendance at an eligible education institution. They now include books, supplies, and equipment needed for a course of study whether or not the materials must be purchased from the educational institution as a condition of enrollment or attendance.

“Related” expenses do not include room and board, student activities, athletics (other than courses that are part of a degree program), insurance, equipment, transportation, or any personal, living, or family expenses. Student-activity fees are included in qualified education expenses only if the fees must be paid to the institution as a condition of enrollment or attendance. For expenses paid with borrowed funds, count the expenses when they are paid, not when borrowings are repaid.

If you pay qualified expenses for a school semester that begins in the first three months of the following year, you can use the prepaid amount in figuring your credit.

You pay $6,500 of tuition in December 2022 for the winter 2023 semester, which begins in January 2023. You can use the $6,500 in figuring your 2022 credit. If you paid in January instead, you would take the credit on your 2023 return.

As future year-end tax planning, this rule gives you a choice of the year to take the credit for academic periods beginning in the first three months of the year; pay by December and take the credit this year; pay in January or later and take the credit next year.

Eligible students. You, your spouse, or an eligible dependent (someone for whom you can claim a dependency exemption, including children under age 24 who are full-time students) can be an eligible student for whom the credit can apply. If you claim the student as a dependent, qualifying expenses paid by the student are treated as paid by you, and for your credit purposes are added to expenses you paid. A person claimed as another person’s dependent can’t claim the credit. The student must be enrolled at an eligible education institution (any accredited public, non-profit or private post-secondary institution eligible to participate in student Department of Education aid programs) for at least one academic period (semester, trimester, etc.) during the year.

No “double-dipping.” The tax law says that you can’t claim both a credit and a deduction for the same higher education costs. It also says that if you pay education costs with a tax-free scholarship, Pell grant, or employer-provided educational assistance, you cannot claim a credit for those amounts.

Income Limits. For 2022, the amount of both the American Opportunity Tax Credit and Lifetime Learning Credit begins to phase out when modified adjusted gross income (MAGI) is between $80,000 and $90,000 ($160,000 and $180,000 for joint returns). The credit cannot be claimed if your MAGI is $90,000 or more ($180,000 or more for joint returns). “Modified AGI” generally means your adjusted gross income. The “modifications” only come into play if you have income earned abroad.

Under the Consolidated Appropriations Act (CAA), the Lifetime Learning Credit and American Opportunity tax credit now have the same credit amounts and phase out ranges.

The American Opportunity Tax Credit

The American Opportunity Tax Credit (AOTC) was made permanent by the Protecting Americans from Tax Hikes Act of 2015 (PATH). The maximum credit, available only for the first four years of post-secondary education, is $2,500. You can claim the credit for each eligible student you have for which the credit requirements are met.

Special Qualification Rules. In addition to being an eligible student, he or she:

  • Must be enrolled in a program leading to a degree, certificate, or other recognized credential;
  • Must be taking at least half of a normal full-time load of courses, for at least one semester or trimester beginning in the year for which the credit is claimed; and
  • May not have any drug-related felony convictions.

Amount of credit. The maximum amount of the AOTC credit is $2,500. Generally, 40 percent of the AOTC is now a refundable credit for most taxpayers, which means that you can receive up to $1,000 even if you owe no taxes.

The Lifetime Learning Credit

You may be able to claim a Lifetime Learning credit of up to $2,500 in 2022 (Consolidated Appropriations Act) for eligible students (subject to reduction based on your AGI). In years prior to 2021, this amount was $2,000 or 20 percent of the first $10,000 of qualified expense. Only one Lifetime Learning Credit can be taken per tax return, regardless of the number of students in the family.

  • The credit can help pay for undergraduate, graduate and professional degree courses, including courses to improve job skills.
  • For courses taken to acquire or improve job skills, there are no requirements as to course loads, so that even one or two courses can qualify.
  • The number of years for which this credit can be claimed is not limited.

Choosing the Credit. You can’t claim both credits for the same person in the same year. But you can claim one credit for one or more family members and the other credit for expenses for one or more others in the same year – for example, an American Opportunity Tax Credit for your child and a Lifetime Learning Credit for yourself.

Electing Not To Take the Credit. There are situations in which the credit is not allowed, or not fully available, if some other education tax benefit is claimed – where the higher education expense deduction is claimed for the same student, see below, or where credit and tax exemption (under a Section 529 or 530 program) are claimed for the same expense. In that case, the taxpayer – or, more likely, the taxpayer’s tax adviser – will determine which tax rule offers the greater benefit and if it’s not the credit, elect not to take the credit.

Qualified Tuition and Related Expenses Deduction

The Taxpayer Certainty and Disaster Tax Relief Act of 2020 repealed the tuition and fees deduction for tax years beginning after 2020. Income limitations for the lifetime learning credit have been increased to help tax filers transition to the lifetime learning credit.

For tax years before 2021, a limited deduction was allowed for “qualified higher education expenses” – tuition and related expenses under the same definition as for tuition credits, above. A $4,000 above the line deduction (Form 8917) was allowed for qualified tuition expenses in 2020, as in 2019 and 2018. The deduction was allowed if a taxpayer’s (modified) adjusted gross income was $80,000 or less ($160,000 or less on a joint return). This tax deduction reduced your amount of income, thereby reducing the amount of tax you paid. You did not need to itemize deductions on Schedule A (Form 1040) in order to take this deduction, which benefited higher earners who could not take the Lifetime Learning Credit because their income exceeded the limits.

For distributions made from qualified tuition programs (QTPs) after 2018, qualified higher education expenses may include:

  • Certain expenses required for a designated beneficiary’s participation in certain apprenticeship programs.
  • No more than $10,000 paid as principal or interest on a qualified student loan of the designated beneficiary or the designated beneficiary’s sibling.

Business expense deduction is allowed, without dollar limit, for education that serves the taxpayer’s business, including employment. a deduction is also allowed for student loan interest, but a taxpayer may not take more than one deduction for the same item. In addition, you cannot claim this deduction if your filing status is married filing separately or if another person can claim an exemption for you as a dependent on his or her tax return.

“Qualified higher education expenses” must be reduced by any such expense paid with an amount treated as tax-free under the rules for excluding income from Series EE bonds, or Section 529 or 530 programs.

Employer-Provided Education Assistance

If your employer paid education assistance benefits (e.g., reimbursements of tuition), part or all of them may be tax-free. You can exclude up to $5,250 per year of the benefits you receive under a qualified educational assistance program. This means your employer shouldn’t include those benefits with your wages, tips and other compensation shown on your Form W-2, box 1. This also means that you don’t have to include the benefits on your income tax return.

You can’t both exclude and deduct the same item, even if it’s otherwise deductible. In order to qualify, your employer must have established an educational assistance plan that does not discriminate in favor of highly paid employees or owners. The exclusion applies to undergraduate level courses other than those involving sports, game, and hobbies. The courses do not need to relate to your job. The exclusion is available for tuition, fees, books, and supplies but not meals, lodging or transportation. And it applies to benefits for graduate-level courses.

In addition to the exclusion for qualifying education plans, your employer can provide reimbursement for business related courses, including graduate courses. Prior to tax year 2018, if your employer did not reimburse you for these expenses, you were entitled to deduct them as a miscellaneous itemized deduction on Schedule A, Itemized Deductions, subject to the two percent deduction floor. To qualify, the expense must meet the requirement of your employer or the law or maintain or improve skills in your current job. The course must not meet minimum education requirements for your job or qualify you for a new trade or business.

However, under the Tax Cuts and Jobs Act of 2017 (“tax reform”), for tax years 2018 through 2025, employee business-related deductions (including education expenses) are disallowed. That is, there are no miscellaneous deductions on Schedule A as there were previously. Self-employed individuals are still able to deduct qualifying educational expenses on Schedule C.

Student Loans

You may be able to deduct interest on student loans. You may also be able to exclude income that you would otherwise have to report if a student loan is canceled.

Interest Deduction. You may deduct student loan interest you pay, including interest paid that’s not currently due because payment is deferred.

Deduction is allowed even though it would otherwise be nondeductible personal interest. But you may deduct only if you are the one legally bound to pay the interest, and only on loans solely for qualified expenses (so not under open credit lines).

The student-loan deduction (up to $2,500 starting in 2013), was made permanent by AFTRA, but only to taxpayers whose AGI is below $160,000 (joint filers) or $80,000 (single filers). Married couples filing separately can’t take the deduction.

The student-loan interest deduction is an “above the line” deduction. In other words, you don’t have to itemize in order to claim it. The loan must have been taken out to cover education expenses of at least half-time study for yourself, your spouse, or a person who was your dependent when you took out the loan.

You cannot deduct interest on a loan from a related person, for example, a relative, or a business entity in which you have an ownership interest as defined by the tax law. And you can’t deduct if you are claimed as a dependent.

Where interest fails to qualify under these tests, consider a home equity loan, interest on which is generally deductible.

Cancellation of Student Loan. If certain requirements are met, cancellations of student loans that are intended to induce students to perform certain services do not increase the student’s gross income. This relief extends to certain private programs, as well as government and public programs.

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by Donald Hayden
02 Aug 2024

The “Nanny Tax” Rules: What To Do If You Have Household Employees

If you have a household employee, you may need to pay state and federal employment taxes. Which forms do you need to file for your household employees? Is your maid, housekeeper, or babysitter covered by the rules? This Financial Guide provides the answers to these and other questions.

This Financial Guide will help you decide whether you have a “household employee,” as defined by the IRS and if you do, whether you need to pay federal employment taxes. It explains the rules for determining, paying, and reporting Social Security tax, Medicare tax, federal unemployment tax, federal income tax withholding, and state unemployment tax for your household employee. It also explains what records you need to keep. In addition, it provides you with the information you need to find out whether you need to pay state unemployment tax for your household employee.

While many people disregard the need to pay taxes on household employees, they do so at the risk of stiff tax penalties. As you will see below, these rules are quite complex and professional tax guidance is highly recommended.

A basic familiarity with these rules will make it easier to work with your tax advisor, saving you time, reducing tax costs, and avoiding tax penalties and interest charges.

  • Who is a Household Employee?
  • How Do You Verify That an Employee Can Legally Work in the United States?
  • Do You Need to Pay Employment Taxes?
  • State Unemployment Taxes
  • Social Security And Medicare Taxes
  • Federal Unemployment (FUTA) Tax
  • Do You Need to Withhold Federal Income Tax?
  • How Do You Handle The Earned Income Credit?
  • How Do You Make Tax Payments?
  • What Forms Must You File?
  • What Records Must You Keep?
  • State Unemployment Tax Agencies
  • Household Employers Checklist
Who is a Household Employee?

The “nanny tax” rules apply to you only if (1) you pay someone for household work and (2) that worker is your employee.

  1. A household employee is someone who does work in or around your home. Examples of household employees include babysitters, nannies, health aides, private nurses, maids, caretakers, yard workers, and similar domestic workers.
  2. A household worker is your employee if you can control not only what work is done, but how it is done. If the worker is your employee, it does not matter whether the work is full-time or part-time, or if you hired the worker through an agency or from a list provided by an agency or association. It also does not matter whether you pay the worker on an hourly, daily, or weekly basis, or by the job.On the other hand, if only the worker can control how the work is done, the worker is not your employee but is self-employed. A self-employed worker usually provides his or her own tools and offers services to the general public in an independent business. If an agency provides the worker and controls what work is done and how it is done, the worker is not your employee.

You pay Emily to babysit your child and do light housework four days a week in your home. Emily follows your specific instructions about household and childcare duties. You provide the household equipment and supplies that Emily needs to do her work. Emily is your household employee.

You pay Nathan to care for your lawn. Nathan also offers lawn care services to other homeowners in your neighborhood. He provides his own tools and supplies, and he hires and pays any helpers he needs. Neither Nathan nor his helpers are your household employees.

How Do You Verify That an Employee Can Legally Work in the United States?

It is unlawful for you to knowingly hire or continue to employ a person who cannot legally work in the United States.

When you hire a household employee to work for you on a regular basis, he or she must complete USCIS Form I-9, Employment Eligibility Verification. It is your responsibility to verify that the employee is either a U.S. citizen or an alien who can legally work and then complete the employer part of the form. Keep the completed form for your records. Do not return the form to the U.S. Citizenship and Immigration Services (USCIS).

Two copies of Form I-9 are contained in the UCIS Employer Handbook. Visit the USCIS website or call 800-767-1833 to order the handbook, additional copies of the form, or to get more information.

Do You Need to Pay Employment Taxes?

If you have a household employee, you may need to withhold and pay Social Security and Medicare taxes, or you may need to pay federal unemployment tax, or you may need to do both. To find out, read the table below.

If you:

Then you need to:
Pay cash wages of $2,600 or more in 2023 to any one household employee.Do not count wages you pay to:

  • Your spouse,
  • Your child under age 21,
  • Your parent, or
  • Any employee under age 18 during 6
 Withhold and pay Social Security and Medicare taxes.

  • The combined taxes are generally 15.3% of cash wages.
  • Your employee’s share is 7.65%.

(You can choose to pay the employee’s share yourself and not withhold it.)

  • Your share is 7.65%.
Pay total cash wages of $1,000 or more in any calendar quarter of 2022 or 2023 to household employees.Do not count wages you pay to:

  • Your spouse,
  • Your child under age 21, or
  • Your parent.
 Pay federal unemployment tax.

  • The tax is 6.0% of cash wages.
  • Wages over $7,000 a year per employee are not taxed.
  • You also may owe state unemployment tax.

If neither of these two columns applies, then you do not need to pay any federal unemployment taxes. However, you may still need to pay state unemployment taxes.

You do not need to withhold federal income tax from your household employee’s wages. But if your employee asks you to withhold it, you can choose to do so.

If your household employee cares for your dependent under the age of 13 or your spouse or dependent who is not capable of self-care so that you can work, you may be able to take an income tax credit of up to 35% (or $1,050) of your expenses for each qualifying dependent. For two or more qualifying dependents, you can claim up to 35% (or $2,100). For higher-income earners, the credit percentage is reduced, but not below 20%, regardless of the amount of AGI. If you can take the credit, then you can include your share of the federal and state employment taxes you pay, as well as the employee’s wages, in your qualifying expenses.

State Unemployment Taxes

To find out whether you need to pay state unemployment tax for your household employee contact your state unemployment tax agency. You’ll also need to determine whether you need to pay or collect other state employment taxes or carry workers’ compensation insurance.

If you do not need to pay Social Security, Medicare, or federal unemployment tax and do not choose to withhold federal income tax, the rest of this publication does not apply to you.

Social Security And Medicare Taxes

Additional Medicare Tax. As of January 1, 2013, employers are responsible for withholding the 0.9% Additional Medicare Tax on an individual’s wages paid in excess of $200,000 in a calendar year. An employer is required to begin withholding Additional Medicare Tax in the pay period in which it pays wages in excess of $200,000 to an employee. There is no employer match for Additional Medicare Tax.

Both you and your household employee may owe social security and Medicare taxes. Your share is 7.65% (6.2% for social security tax and 1.45% for Medicare tax) of the employee’s social security and Medicare wages. Your employee’s share is 6.2% for social security tax and 1.45% for Medicare tax for wages below the Additional Medicare Tax threshold (see above).

You are responsible for payment of your employee’s share of the taxes as well as your own. You can either withhold your employee’s share from the employee’s wages or pay it from your own funds.

Social Security and Medicare Wages

You figure Social Security and Medicare taxes on the Social Security and Medicare wages you pay your employee. If you pay your household employee cash wages of $2,600 or more in 2023, all cash wages you pay to that employee in 2023 (regardless of when the wages were earned) up to $160,200 are social security wages and all cash wages are Medicare wages. However, any non-cash wages (food, lodging, clothing, and other non-cash items) you pay do not count as social security and Medicare wages. If you pay the employee less than $2,600 in cash wages in 2023, none of the wages you pay the employee are Social Security and Medicare wages, and neither you nor your employee will owe Social Security or Medicare tax.

Wages Not Counted

Do not count wages you pay to any of the following individuals as Social Security and Medicare wages:

  1. Your spouse.
  2. Your child who is under age 21.
  3. Your parent.

    However, you should count wages to your parent if both of the following apply: (a) your child lives with you and is either under age 18 or has a physical or mental condition that requires the personal care of an adult for at least four continuous weeks in a calendar quarter, and (b) you are divorced and have not remarried, or you are a widow or widower, or you are married to and living with a person whose physical or mental condition prevents him or her from caring for your child for at least four (4) continuous weeks in a calendar quarter.

  4. An employee who is under age 18 at any time during the year.

    However, you should count these wages to an employee under 18 if providing household services is the employee’s principal occupation. If the employee is a student, providing household services is not considered to be his or her principal occupation.

Also, if your employee’s Social Security and Medicare wages reach $160,200 in 2023, do not count any wages you pay that employee during the rest of the year as Social Security wages to figure Social Security tax (but continue to count the employee’s cash wages as Medicare wages to figure Medicare tax).

You figure federal income tax withholding on both cash and non-cash wages (based on their value). However, do not count as wages any of the following items:

  • Meals provided at your home for your convenience.
  • Lodging provided at your home for your convenience and as a condition of employment.
  • $300 a month in 2023 for transit passes that you give your employee or, in some cases, for cash reimbursement you make for the amount your employee pays to commute to your home by public transit. A transit pass includes any pass, token, fare card, voucher, or similar item entitling a person to ride on mass transit, such as a bus or train.
  • Up to $300 a month in 2023 to reimburse your employee for the cost of parking at or near your home or at or near a location from which your employee commutes to your home.

Withholding the Employee’s Share

You should withhold the employee’s share of Social Security and Medicare taxes if you expect to pay your household employee Social Security and Medicare wages of $2,600 or more in 2023. However, if you prefer to pay the employee’s share yourself; see “Not Withholding the Employee’s Share” in the next section.

You may withhold the employee’s share of the taxes even if you are not sure your employee’s Social Security and Medicare wages will be $2,600 or more in 2023. If you withhold the taxes but then actually pay the employee less than $2,600 in Social Security and Medicare wages for the year, you should repay the employee.

You pay withheld taxes as part of your regular income tax obligation. You don’t deposit them periodically subject to an exception for business owners. See “Payment Options for Business Employers” below.

Withhold 7.65% (6.2% for Social Security tax and 1.45% for Medicare tax) from each payment of Social Security and Medicare wages. Wages exceeding the $200,000 (single filer) threshold amount are subject to the additional Medicare tax or 0.9%. Instead of paying this amount to your employee, you will pay the IRS 7.65% for your share of the taxes. Do not withhold any social security tax after your employee’s social security wages for the year reach $160,200 in 2023.

If you make an error by withholding too little, you should withhold additional taxes from a later payment. If you withhold too much, you should repay the employee.

You hire a household employee (who is an unrelated individual over age 18) to care for your child and agree to pay cash wages of $100 every Friday. You expect to pay your employee $2,200 or more for the year. You should withhold $7.65 from each $100 wage payment and pay your employee the remaining $92.35. The $7.65 is the sum of $6.20 ($100 x 6.2%) for your employee’s share of Social Security tax and $1.45 ($100 x 1.45%) for your employee’s share of Medicare tax (for wages under $200,000 for single filers). You will pay $7.65 from your own funds when you pay the taxes.

Not Withholding the Employee’s Share

If you prefer to pay your employee’s Social Security and Medicare taxes from your own funds, you do not have to withhold them from your employee’s wages. The Social Security and Medicare taxes you pay to cover your employee’s share must be included in the employee’s wages for income tax purposes. However, they are not counted as Social Security and Medicare wages or as federal unemployment (FUTA) wages.

You hire a household employee (who is an unrelated individual over age 18) to care for your child and agree to pay cash wages of $100 every Friday. You expect to pay your employee $2,200 or more for the year. You decide to pay your employee’s share of Social Security and Medicare taxes from your own funds. You pay your employee $100 every Friday without withholding any Social Security or Medicare taxes. For each wage payment, you will pay $15.30 when you pay the taxes. This is $7.65 ($6.20 for Social Security tax plus $1.45 for Medicare tax) to cover your employee’s share plus the $7.65 for your share. For income tax purposes, your employee’s wages each payday are $107.65 ($100 plus the $7.65 that you will pay to cover your employee’s share of Social Security and Medicare taxes).

Federal Unemployment (FUTA) Tax

The federal unemployment tax is part of the federal and state program under the Federal Unemployment Tax Act (FUTA) that pays unemployment compensation to workers who lose their jobs. Like most employers, you may owe both the federal unemployment tax (the FUTA tax) and a state unemployment tax. Or, you may owe only the FUTA tax or only the state unemployment tax. To find out whether you will owe state unemployment tax, contact your state’s unemployment tax agency. See the list of state unemployment agencies at the end of this Guide for the address.

The FUTA tax is 6.0% of your employee’s FUTA wages. However, you may be able to take a credit of up to 5.4% against the FUTA tax, resulting in a net tax rate of 0.6%. Your credit for 2023 is limited unless you pay all the required contributions for 2023 to your state unemployment fund by April 15, 2024. The credit you can take for any contributions for 2023 that you pay after April 15, 2024, is limited to 90% of the credit that would have been allowable if the contributions were paid on or before that day.

The 5.4% credit is reduced for wages paid in a credit reduction state. See the Instructions for Schedule H (Form 1040).

Do not withhold the FUTA tax from your employee’s wages. You must pay it from your own funds.

You figure the FUTA tax on the FUTA wages you pay. If you pay cash wages to all of your household employees totaling $1,000 or more in any calendar quarter of 2022 or 2023, the first $7,000 of cash wages you pay to each household employee in 2023 is FUTA wages. (A calendar quarter is January through March, April through June, July through September, or October through December.) If your employee’s cash wages reach $7,000 during the year, do not figure the FUTA tax on any wages you pay that employee during the rest of the year. For a discussion of “cash wages,” see the section on Social Security Wages, above.

If you pay less than $1,000 cash wages in each calendar quarter of 2023, but you had a household employee in 2022, the cash wages you pay in 2023 may still be FUTA wages. They are FUTA wages if the cash wages you paid to household employees in any calendar quarter of 2022 totaled $1,000 or more.

Do not count wages you pay to any of the following individuals as FUTA wages:

  1. Your spouse.
  2. Your child who is under age 21.
  3. Your parent.

You hire a household employee (not related to you) on January 1, 2023, and agree to pay cash wages of $200 every Friday. During January, February, and March, you pay the employee cash wages of $2,600. Because you pay cash wages of $1,000 or more in a calendar quarter of 2023, the first $7,000 of cash wages you pay the employee (or any other employee) in 2023 or 2022 is FUTA wages. The FUTA wages you pay may also be subject to your state’s unemployment tax.

During 2023, you pay your household employee cash wages of $10,400. You pay all the required contributions for 2023 to your state unemployment fund by April 15, 2024. Your FUTA tax for 2023 is $42 ($7,000 x 0.6%).

Do You Need to Withhold Federal Income Tax?

You are not required to withhold federal income tax from wages you pay a household employee. You should withhold federal income tax only if your household employee asks you to withhold it and you agree. The employee must give you a completed Form W-4, Employee’s Withholding Allowance Certificate.

Form W-4, Employee’s Withholding Certificate, was redesigned in 2020.

If you agree to withhold federal income tax, you are responsible for paying it to the IRS.

Wages

You figure federal income tax withholding on both cash and non-cash wages you pay. Measure wages you pay in any form other than cash by the value of the non-cash item.

Do not count as wages any of the following items:

  • Meals provided at your home for your convenience.
  • Lodging provided at your home for your convenience and as a condition of employment.
  • Up to $300 a month in 2023 for bus or train tokens (passes) you give your employee, or for any cash reimbursement you make for the amount your employee pays to commute to your home by public transit.
  • Up to $300 a month in 2023 for the value of parking you provide your employee at or near your home or at or near a location from which your employee commutes to your home.

Paying Tax without Withholding

Any income tax you pay for your employee without withholding it from the employee’s wages must be included in the employee’s wages for federal income tax purposes. It is also counted as Social Security and Medicare wages and as federal unemployment (FUTA) wages.

How Do You Handle The Earned Income Credit?

Certain workers can take the earned income tax credit (EITC) on their federal income tax return. This credit reduces their tax or allows them to receive a payment from the IRS if they do not owe tax. You may have to make advance payments of part of your household employee’s EITC along with the employee’s wages. You also may have to give your employee a notice about the EITC.

Notice about the EITC

The employee’s copy (Copy B) of IRS 2023 Form W-2, Wage and Tax Statement has a statement about the EITC on the back.

If you give your employee that copy by January 31, 2023 (as discussed under Form W-2), you do not have to give the employee any other notice about the EITC.

Otherwise, you must give your household employee a notice about the EITC only if you agree to withhold federal income tax from the employee’s wages but the income tax withholding tables show that no tax should be withheld. Even if not required, you are encouraged to give the employee a notice about the EITC if his or her 2023 wages are less than $63,698.

If you do not give your employee Copy B of the IRS Form W-2, your notice about the EITC can be any of the following:

  • A substitute Form W-2 with the same EITC information on the back of the employee’s copy that is on Copy C of the IRS Form W-2,
  • Notice 797, Possible Federal Tax Refund Due to the Earned Income Credit (EITC), or
  • Your own written statement with the same wording as Notice 797.

If you give your employee a substitute Form W-2 on time which lacks the required EITC information, you must give notice about the 6IC to the employee within one week of the date you gave him or her the substitute Form W-2. If Form W-2 is required, but not given on time, you must give the employee notice about 2024 EITC by January 31, 2024. If Form W-2 is not required, you must give your notice to the employee by February 10, 2024.

How Do You Make Tax Payments?

When you file your 2023 federal income tax return in 2024, attach Schedule H, Household Employment Taxes. Use this Schedule, discussed further below, to figure your household employment taxes. You will add the federal employment taxes on the wages you pay to your household employee in 2023, less any advance earned income credit payments you make to the employee, to your income tax. The amount you owe with your return is due to the IRS by April 15, 2024.

You can avoid owing tax with your return if you pay enough federal income tax before you file to cover the employment taxes for your household employee, as well as your income tax. If you are employed, you can ask your employer to withhold more federal income tax from your wages in 2023. If you get a pension or annuity, you can ask for more federal income tax withholding from your benefits. Or you can make estimated tax payments for 2023 to the IRS, or increase your payments if you already make them.

Asking for More Federal Income Tax Withholding

If you are employed and want more federal income tax withheld from your wages to cover the employment taxes for your household employee, give your employer a new Form W-4, Employee’s Withholding Allowance Certificate.

If you get a pension or annuity and want more federal income tax withheld to cover the employment taxes for your household employee, give the payer a new Form W-4P, Withholding Certificate for Pension or Annuity Payments (or a similar form provided by the payer).

Paying Estimated Tax

If you want to make estimated tax payments to cover the employment taxes for your household employee, get Form 1040-ES, Estimated Tax for Individuals. Use its payment vouchers to make your payments. You can pay all of the employment taxes at once or in installments. If you have already made estimated tax payments for 2023, you can increase your remaining payments to cover the employment taxes. Estimated tax payments for 2023 are due April 18, June 15, September 15, 2023, and January 16, 2024.

Payment Option for Business Employers

If you own a business as a sole proprietor or your home is on a farm operated for profit, you can choose either of two ways to pay the 2023 federal employment taxes for your household employee. You can pay them with your federal income tax as described above, or you can include them with your federal employment tax deposits or other payments for your business or farm employees.

If you pay the employment taxes for your household employee with business or farm employment taxes, you must report them with those taxes on Form 941 or Form 943 and on Form 940 (or 940-EZ).

What Forms Must You File?

You must file certain forms to report your household employee’s wages and the federal employment taxes for the employee if you pay the employee:

  1. Social Security and Medicare wages,
  2. FUTA wages, or
  3. Wages from which you withhold federal income tax.

The employment tax forms and instructions you need for 2023 will be sent to you automatically in January 2024 if you reported employment taxes for 2023 on Schedule H (Form 1040), Household Employment Taxes.

Employer Identification Number (EIN)

You must include your employer identification number (EIN) on the forms you file for your household employee. An EIN is a 9-digit number issued by the IRS and is not the same as a Social Security number.

You ordinarily will have an EIN if you previously paid taxes for employees, either as a household employer or in a business you own as a sole proprietor, or if you have a Keogh Plan. If you already have an EIN, use that number. If you do not have an EIN, get Form SS-4, Application for Employer Identification Number. The instructions for Form SS-4 explain how you can get an EIN immediately by telephone or in about four weeks if you apply by mail.

Form W-2

A separate 2023 Form W-2, Wage and Tax Statement, must be filed for each household employee to whom you pay:

  • Social Security and Medicare wages of $2,600 or more, or
  • Wages from which you withhold federal income tax.

You must complete Form W-2 and give Copies B, C, and 2 to your employee by January 31, 2023, You must send Copy A of Form W-2 with Form W-3, Transmittal of Wage and Tax Statements, to the Social Security Administration by January 31, 2023.

Schedule H

Use Schedule H (Form 1040), Household Employment Taxes, to report the federal employment taxes for your household employee if you pay the employee:

  1. Social Security and Medicare wages of $2,600 or more in 2023,
  2. FUTA wages, or
  3. Wages from which you withhold federal income tax.

File Schedule H with your 2023 federal income tax return by April 15, 2024. If you get an extension to file your return, the extension will also apply to your Schedule H.

If you are not required to file a 2023 tax return, you must file Schedule H by itself. See the Schedule H instructions for details.

Business Employment Tax Returns

Do not use Schedule H (Form 1040) if you choose to pay the employment taxes for your household employee with business or farm employment taxes. Instead, include the Social Security, Medicare, and withheld federal income taxes for the employee on the Forms 941, Employer’s Quarterly Federal Tax Return, that you file for your business or on Form 943, Employer’s Annual Tax Return for Agricultural Employees, that you file for your farm. Include the FUTA tax for the employee on your Form 940 (or 940-EZ), Employer’s Annual Federal Unemployment (FUTA) Tax Return.

If you report the employment taxes for your household employee on Form 941 or Form 943, file Form W-2 for the employee with the Forms W-2 and Form W-3 for your business or farm employees.

What Records Must You Keep?

Keep your copies of Schedule H or other employment tax forms you file and related Forms W-2, W-3, W-4, and W-5. You must also keep records to support the information you enter on the forms you file. If you are required to file Form W-2, you will need to keep a record of your employee’s name, address, and Social Security number.

Wage and Tax Records

On each payday you should record the date and amounts of:

  • Your employee’s cash and non-cash wages,
  • Any employee Social Security tax you withhold or agree to pay for your employee,
  • Any employee Medicare tax you withhold or agree to pay for your employee,
  • Any federal income tax you withhold,
  • Any advance EITC payments you make, and
  • Any state employment taxes you withhold.

Employee’s Social Security Number

You must keep a record of your employee’s name and Social Security number exactly as they appear on his or her Social Security card if you pay the employee:

  • Social Security and Medicare wages, or
  • Wages from which you withhold federal income tax.

You must ask for your employee’s Social Security number no later than the first day on which you pay the wages. You may wish to ask for it when you hire your employee.

An employee who does not have a Social Security number must apply for one on Form SS-5, Application for a Social Security Card. An employee who has lost his or her Social Security card or whose name is not correctly shown on the card should apply for a new card. Employees may get Form SS-5 from any Social Security Administration office or by calling l-800-772-1213.

How Long To Keep Records

Keep your employment tax records for at least four years after the due date of the return on which you report the taxes or the date the taxes were paid, whichever is later.

State Unemployment Tax Agencies

Alabama
Unemployment Office
649 Monroe St.
Montgomery, AL 36131
(866) 234-5382

Alaska
Employment Security Tax
Department of Labor and Workforce Development
PO Box 115509
Juneau, AK 99811-5509
(888) 448-3527

Arizona
Department of Economic Security
Unemployment Insurance Tax
PO Box 6028
Phoenix, AZ 85005-6028
(602) 542-5954

Arkansas
Department of Workforce Services
PO Box 2981
Little Rock, AR 72203-2981
(501) 682-2121
(855) 225-4440

California
Employment Development Department
P.O. Box 826880 – UIPCD, MIC 40
Sacramento, CA 94280-0001
(888) 745-3886

Colorado
Unemployment Insurance Operations
Department of Labor and Employment
PO Box 8789
Denver, CO 80201-8789
(800) 480-8299

Connecticut
Connecticut Department of Labor
200 Folly Brook Blvd.
Wethersfield, CT 06109-1114
(860) 263-6550

Delaware
Division of Unemployment Insurance
Department of Labor
4425 North Market Street
Wilmington, DE 19802
(302) 761-8446

District of Columbia
Department of Employment Services
Office of Unemployment Compensation Tax Division
4058 Minnesota Ave NE Floor 4
Washington, DC 20019
(202) 698-4817

Florida
Unemployment Compensation Services
Agency for Workforce Innovation
107 E. Madison Street
Caldwell Building
Tallahassee, FL 32399-4120
(850) 245-7105

Georgia
Department of Labor
148 Andrew Young International Blvd.
Atlanta, GA 30303
(404) 232-3301 (direct line for employer tax liability)

Hawaii
Department of Labor and Industrial Relations
830 Punchbowl Street, Rm. 437
Honolulu, HI 96813
(808) 586-8915

Idaho
Department of Employment
317 Main Street
Boise, ID 83735
(800) 448-2977

Illinois
Department of Employment Security
33 South State Street
Chicago, IL 60603
(800) 247-4984

Indiana
Department of Workforce Development
10 North Senate Avenue
Indiana Government Center South
Indianapolis, IN 46204
(800) 437-9136

Iowa
Workforce Development
1000 East Grand Avenue
Des Moines, IA 50319-0209
(515) 281-5387 (Des Moines)
(888) 848-7442

Kansas
Department of Labor
401 SW Topeka Blvd.
Topeka, KS 66603-3182
(785) 296-5027

Kentucky
Division for Employment Services
275 East Main Street
Frankfort, KY 40602
(502) 564-2272

Louisiana
Louisiana Workforce Commission
1001 North 23rd Street
PO Box 94094
Baton Rouge, LA 70804-9094
(225) 342-3111

Maine
Department of Labor
54 State House Station
Augusta, ME 04333
(207) 621-5120

Maryland
Department of Labor, Licensing & Regulation
Division of Labor and Industry
1100 North Eutaw Street, Room 600
Baltimore, MD 21201
(410) 767-2241

Massachusetts
Division of Employment and Training
Charles F. Hurley Building
19 Staniford Street
Boston, MA 02114
(617) 626-6560

Michigan
Unemployment Insurance Agency
3024 W. Grand Boulevard
Detroit, MI 48202-6024
(855) 484-2636

Minnesota
Department of Employment & Economic Development
332 Minnesota Street
Suite E200
St. Paul, MN 55101-1351
(651) 296-6141

Mississippi
Department of Employment Security
1235 Echelon Pkwy
Jackson, MS 39213
(601) 321-6000

Missouri
Division of Employment Security
421 E Dunklin Street
Jefferson City, MO 65101
(573) 751-3215

Montana
Unemployment Insurance Bureau
1327 Lockey Avenue
Helena, MT 59601
(406) 444-3834

Nebraska
Department of Labor
550 South 16th
PO Box 94600
Lincoln, NE 68509-4600
(402) 471-9940

Nevada
Department of Employment Training and Rehabilitation
Employment Security Division
500 East Third Street
Carson City, NV 89713-0030
(775) 486-6310

New Hampshire
Department of Employment Security
45 South Fruit Street
Concord, NH 03301
(603) 228-4100

New Jersey
Department of Labor & Workforce Development
P.O. Box 110
Trenton, NJ 08625-0110
(609) 292-2810

New Mexico
Department of Workforce Solutions
401 Broadway NE
Albuquerque, NM 87102
(877) 664-6984

New York
Department of Labor
WA Harriman State Office Campus
Building 12, Room 356
Liability and Determination Section
Albany, NY 12240
(888) 899-881

North Carolina
Department of Commerce
Employment Security Commission
301 North Wilmington Street
Raleigh, North Carolina 27601-1058
(919) 814-4600

North Dakota
Job Service North Dakota
PO Box 5507
Bismarck, ND 58506-5507
(701) 328-2814

Ohio
Department of Job & Family Services
PO Box 182404
Columbus, OH 43218-2404
(877) 644-6562

Oklahoma
Employment Security Commission
2401 N Lincoln Blvd
Oklahoma City, OK 73105
(405) 557-7100

Oregon
Employment Department
875 Union Street, NE
Salem, OR 97311
(503) 947-1394

Pennsylvania
Department of Labor and Industry
7th and Forster Street
Harrisburg, PA 17120
(866) 403-6163

Puerto Rico
Department of Labor and Human Resources
PO Box 1020
San Juan, PR 00919-1020
(787) 754-5353

Rhode Island
Division of Taxation
One Capitol Hill
Providence, RI 02908
(401) 574-8700

South Carolina
Employment Security Commission
PO Box 995
Columbia, SC 29202-0995
(803) 737-2400

South Dakota
Department of Labor & Regulation
123 W. Missouri Avenue
Pierre, SD 57501-0405
(605) 626-2312

Tennessee
Department of Labor and Workforce Development
220 French Landing Drive
Nashville, TN 37243
(844) 224-5818

Texas
Texas Workforce Commission
101 E 15th St, Rm 122
Austin, TX 78778-0001
(512) 463-2699

Utah
Department of Workforce Services
PO Box 45249
140 East 300 South
Salt Lake City, UT 84145-0249
(801) 526-9235

Vermont
Department of Labor
PO Box 488
5 Green Mountain Drive
Montpelier, VT 05601-0488
(802) 828-4000

Virgin Islands
Department of Labor
2353 Kronprindsens Gade
Charlotte Amalie, St. Thomas, VI 00802
(340) 776-3700

Virginia
Employment Commission
PO Box 1358
703 E. Main Street
Richmond, VA 23219
(866) 832-2363

Washington
Employment Security Department
PO Box 9046
212 Maple Park Ave SE
Olympia, WA 98507
(360) 902-9500

West Virginia
Workforce West Virginia
PO Box 2753
1321 Plaza East Shopping Center
Charleston, WV 25330
(304) 558-0291

Wisconsin
Department of Workforce Development
PO Box 7946
Madison, WI 53707-7946
(608) 266-3131

Wyoming
Unemployment Tax Division
PO Box 2760
100 West Midwest
Casper, WY 82602-2760
(307) 235-3264

Household Employers Checklist

You may need to do the following things when you have a household employee: When you hire a household employee:

  • Find out if the person can legally work in the United States.
  • Find out if you need to pay state taxes.

When you pay your household employee:

  • Withhold Social Security and Medicare taxes.
  • Withhold federal income tax.
  • Make advance payments of the earned income credit.
  • Decide how you will make tax payments.
  • Keep records.

By January 31, 2024:

  • Get an employer identification number, if needed.
  • Give your employee Copies B, C, and 2 of Form W-2, Wage and Tax Statement.

By January 31, 2024:

  • Send Copy A of Form W-2 to the Social Security Administration.

By April 15, 2024:

  • File Schedule H (Form 1040), Household Employment Taxes, with your tax return.

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