Hire your children to save taxes for your business and your family

It can be difficult in the current job market for students and recent graduates to find summer or full-time jobs. If you’re a business owner with children in this situation, you may be able to provide them with valuable experience and income while generating tax savings for both your business and your family overall.

Shifting income

By shifting some of your business earnings to a child as wages for services performed by him or her, you can turn some of your high-taxed income into tax-free or low-taxed income. For your business to deduct the wages as a business expense, the work done by the child must be legitimate and the child’s wages must be reasonable.

Here’s an example of how this works: A business owner operating as a sole proprietor is in the 37% tax bracket. He hires his 17-year-old son to help with office work full-time during the summer and part-time into the fall. The son earns $6,100 during the year and doesn’t have any other earnings.

The business owner saves $2,220.00 (37% of $6,000) in income taxes at no tax cost to his son, who can use his $12,000 standard deduction (for 2018) to completely shelter his earnings. The business owner can save an additional $2,220 in taxes if he keeps his son on the payroll longer and pays him an additional $6,000. The son can also shelter additional income from tax by making a tax-deductible contribution to his own IRA by potentially paying the son $17,500.

Another benefit of paying children is satisfying the requirement of W-2 wages being paid by the business to qualify for the 20% deduction of qualified business income.  With incomes in excess of $315,000 for married filing jointly ($157,500 for non-married), in order to qualify for the 20% business deduction, the deduction will need to be less than or equal to 50% of the wages paid during the year.  At higher incomes, this can be tough depending on how much has been paid to the owner during the year.

Family taxes will be cut even if the employee-child’s earnings exceed his or her standard deduction and IRA deduction. That’s because the unsheltered earnings will be taxed to the child beginning at a rate of 10% instead of being taxed at the parent’s higher rate.

Saving employment taxes

If your business isn’t incorporated or a partnership that includes nonparent partners, you might also save some employment tax dollars. Services performed by a child under age 18 while employed by a parent aren’t considered employment for FICA tax purposes. And a similar exemption applies for federal unemployment tax (FUTA) purposes. It exempts earnings paid to a child under age 21 while employed by his or her parent.

If you have questions about how these rules apply in your particular situation or would like to learn about other family-related tax-saving strategies, contact us.

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