Hiring your children may save you on taxes
If you are a business owner, there are tax breaks and some nontax benefits when hiring your children. The benefits are all around. Kids can obtain valuable life experience through their job while at the same time, learning how to manage money and save for college. The benefits you could receive are the ability to:
- Turn your high-taxed income into tax-free or low-taxed income,
- Capitalize on payroll tax savings (depending on their age and how your business is organized), and
- Create contribution opportunities to a retirement plan for the child.
It must be a real job
When hiring your child, you receive a business tax deduction for employee wage expenses. This deduction reduces your federal, self-employment, and state income tax bill (if applicable). For your business to deduct your child’s wages as a business expense, the job the child has must be legitimate, and the child’s salary must be reasonable.
You can also save on income taxes at no tax cost to your child. How much you save is determined by your tax bracket. The standard deduction for 2019 is $12,200 to shelter your child’s earnings completely.
For example, let’s say a business owner operates as a sole proprietor and is in the 37% tax bracket. He hires his 16-year-old son to help with office work on a full-time basis during the summer and part-time into the fall. The son earns $10,000 during 2019 and doesn’t have any other earnings.
The business owner saves $3,700 (37% of $10,000) in income taxes at no tax cost to his son, who can use his 2019 $12,200 standard deduction to completely shelter his earnings.
The family’s taxes are cut even if the child’s earnings exceed his or her standard deduction. The unsheltered gains will be taxed to the child beginning at a rate of 10%, instead of being taxed at the parent’s higher rate.
How payroll taxes might be saved
If your business isn’t incorporated, your child’s wages are exempt from Social Security, Medicare, and FUTA taxes if certain conditions are met. Your child must be under age 18 for this to apply (or under age 21 in the case of the FUTA tax exemption). Contact us for how this works.
Be aware that there’s no FICA or FUTA exemption for employing a child if your business is incorporated or a partnership that includes nonparent partners.
Start saving for retirement early
As a business owner, you also may be able to provide your child with retirement benefits, depending on the type of plan you have and how it defines qualifying employees. Moreover, because your child has earnings from his or her job, he can contribute to a traditional IRA or Roth IRA. For the 2018 tax year, a working child can contribute the lesser of his or her earned income or $6,000 to an IRA or a Roth.
Raising tax-smart children
Therefore, hiring your child can be a tax-smart idea. Be sure to keep the same records as you would for other employees to substantiate the hours worked and duties performed (such as timesheets and job descriptions). Issue your child a Form W-2.
If you have any questions about how these rules apply to your situation, don’t hesitate to contact us.