Small Business Owners Hire Their Kids for Tax Savings

By on January 15, 2017

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Now that last year’s tax return is filed it is time to find tax savings for this year going forward. If you are a small business owner – sole proprietor or husband/wife partnership – did you know that employing your children can be an excellent way to limit your tax liability?

For any minor child – under age 18 – hired to do legitimate work and paid an honest wage, parents may be able to shift part of their business income from their tax bracket (usually higher) to that of their child’s. This can result in both substantial tax savings and future savings for college or retirement.

Note: These tax benefits may not apply for children who are employed by S Corporations, partnerships that include nonparent partners or corporations.

How Employing Your Child Bring Tax Benefits

Hiring your child is a great way to get tax benefits and provide a child with money and valuable experience, but it can be a nightmare if you adhere to the detail rules in the tax code(s). The IRS is well aware of the tax benefits of hiring a child, so auditors will be on the lookout for taxpayers stretching the truth to claim exemptions.

For example, your child must be under the age of 18, however, how young is too young to legitimately employ? The IRS has accepted that a child of seven (7) yeas may be an employee, so while it may be possible to claim children younger, you could trigger a tax review. If the IRS concludes that your children are not really employees, you may lose your tax deductions for their salary and benefits, and have to pay tax on their wages.

To avoid losing your tax breaks, here are some important reminders and required procedures you and your trusted financial advisor(s) will want to review before adding your child to the payroll.

Your Child Must Be a Real Employee

For the employer to deduct the wages, the child must actually be a bona fide employee, performing realistic (age appropriate) skills. There are probably lots of things your child can help you with, such as answering phones or cleaning the office. Many tech-savvy teens are adept at building or running a business’ website and conducting social media campaigns. They can even work remotely from a dorm (until they turn 18).

Any real work for your business can qualify, however you will get no business deductions when you pay your child for personal services, such as babysitting or mowing your lawn at home..

Here are five ways you can ensure your child is seen as a real employee:

  1. Write up a job description delineating their duties and responsibilities, expected hours of work, pay, etc..
  2. Complete and sign a W4 Form for your child.
  3. Keep regular timesheets for your child.
  4. Pay them with a normal payroll check.
  5. Conduct performance reviews (great for justifying periodic raises).

Their Wages Must Be Reasonable

When you hire your children, it may be advantageous to shift as much of your income as possible to them – assuming they are in a lower income tax bracket – but you cannot just pay any amount you choose. Just as with any other employee, their compensation (including any benefits) must be reasonable for the jobs they perform. Find out what workers performing similar services in your area are being paid to use as a gauge.

You will need to show how much you paid your child over the year, so pay them with a normal payroll check. If you pay in cash and lose track of the amount they received you risk the ability to claim the largests deduction possible. In addition, parents should not treat any money paid towards a child’s meals or education as wages. Parents have a legal duty to support children, so the IRS can disallow a deduction for wages used to provide support, such as meals.

Other Legal Requirements of Employment are Applied

Finally, you must comply with most of the same legal requirements when you hire a child as you do when you hire any other employee. Your child’s wages are exempt from federal employment taxes (Social Security, Medicare and Unemployment FUTA). Moreover, most states will allow you to waive any Workers’ Compensation cost as your child is already covered under your family medical plan.

Establish a Roth IRA for Your Child

If you hire your children to work in your business, you can open an individual retirement account for each child. In addition to being able to put money away without any tax liability, it also allows the business owner to add to the savings account. A Roth or traditional IRA has the advantages of being tax-free income if the child waits until he is ready to retire before withdrawing from the account.

Although there may be some concern about the lack of liquidity at such a young age, your child has some options for accessing these funds if necessary. In many cases, your child may withdraw funds from the IRA for college or medical expenses without penalties or fees.

Filing Tax Returns

If done properly, wages paid to your child are fully deductible as a business expense – this may lower your business’ net income and tax liability. Your child (under the age of 18) can earn up to $6,300 before any income tax is assessed; this can be increased to $11,800 when $5,550 is contributed to the IRA in the child’s name.

If your child’s income exceeds the standard deduction of $6,300, they will have to file their own tax returns. You may still want to file tax returns on their behalf if you, as the employer, withheld federal or state taxes from their paycheck. The only way to collect any tax refund owed to them is to file.

Consult with Your Financial Advisors

When you pay your children reasonable wages to work in your family-owned small business, not only are you helping them jumpstart their college (or retirement) savings and learn valuable skills, but you could earn a few special tax breaks in the process. In addition to minor children – who offer excellent tax benefits – there may be advantages to employing spouses and parents over regular employees.

Everyone’s financial situation is different. Speak with your trusted financial and legal advisors, and seek the advice of a tax professional so you can identify the right course of action for your business and your family.

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About Kendrick Lee

Senior writer and business columnist for FSN - Successful businesses, large or small, will lend to successful owners, employees, local communities and markets for continued economic growth. Since there are so many risks, finances and procedures to consider when running a business, Kendrick is dedicated to sharing business tips, strategies and ideas in the public sphere. Find Kendrick on !

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