Could you use some extra help in the business this summer and an excellent tax write-off? Putting your children work in your business, even if only for the summer, is one of the most underutilized tax-saving strategies today. It can also be a great way to teach your kids some work ethic, money-management skills, and kick start their retirement or college savings plan.
I've found that many business owners simply don't realize placing children under the age of 18 on the payroll, or even grandchildren or adult children, is an excellent strategy to minimize tax liability.
However, there are procedures you need to follow if you hire your children, and it is important you follow the right procedure or it could backfire on you.
Not Withholding. A Simple and Easy Strategy
Many business owners and parents don't realize that it’s not required to withhold any payroll taxes when you're paying your children under 18. This is the dreaded Federal Unmployment Tax Act (FUTA), State Unemployment Tax Act (SUTA), and Federal Insurance Contributions Act (FICA) taxes we all hate to withhold and match for our employees. Moreover, in almost every state you can waive your children out of any Workers' Compensation coverage, just like yourself, because you cover them under your family medical plan.
- This provision to not withhold payroll taxes from your children under 18, only applies to Sole Proprietorships or a Limited Liability Company (LLC) taxed as a partnership and owned by mom and/or dad. However, if you have an S- or a C-corporation you do not receive this benefit of avoiding payroll taxes when paying your children. If you pay your children out of a corporation, you'll have to withhold payroll taxes.
- To avoid the withholding problem if you are an S- or C-Corporation, I recommend you pay children out of a family management company (Sole Proprietorship) paid a management fee from the corporation. This can be an excellent central entity to hire the kids and provide independent services to one or more of your companies.
- If you are paying children over the age of 18 or grandchildren, you have the option of treating them as either as subcontractors or employees. You will thus have to issue a 1099-MISC form next January if they are truly acting like a subcontractor, or start a W-2 and withhold typical payroll taxes if they are employees.
Your Children Shouldn’t Pay Taxes Either
Another exciting aspect to this strategy, is that all of us, including our children don't pay federal income taxes on the first $6,300 of income this year. It's called the Standard Deduction. Pay someone who isn't a relative to work for you, and they take that $6,300 of tax-free income home with them. Hire your child, and you keep it in the family. Plus, you can still claim your children on your tax return as a dependent and take the exemption, even take the Child Tax Credit.
Some business owners ask: "What about the 'kiddie tax'? Aren't the kids going to end up paying taxes on their income at our rates anyway?" The answer is no. The kiddie tax only applies to unearned or "portfolio" income and if the children are working in the business it will clearly be “earned” income.
Keep It Legitimate
I want to be crystal clear that I'm not advocating you create some sham job for your kids to shield income from taxes. They have to be legitimately involved in the business. If the Internal Revenue Service audits you, you'll have to produce records of their time worked, and you'll have to demonstrate that the wages paid were reasonable.
Do not hire your children simply to do "family chores." The chores will not qualify as a valid deduction, and you could set yourself up for an audit. Pay your children for services they perform for your business, and you'll actually generate an expense for your income taxes by pushing income to your children.
Take It To The Next Level. Create a Retirement and College Savings Account
An incredible side benefit to this strategy is that once your kids have “earned” income they can now contribute to a Roth or Standard IRA. In fact, the Roth IRA contributions could be pulled out later for college expenses penalty and tax free (the earnings, of course, will continue to build and grow with the Roth IRA). This is a great opportunity to kick-start your their retirement savings or even college savings plan with tax-free dollars or income at their tax bracket.
My point is this: Quit paying taxes at your rates and paying for your kids expenses and contributing to their college savings plan…put them on the payroll and let them pay their own expenses.
I have seen this strategy not only save clients thousands of dollars in taxes, but literally change the lives of their families. Children begin to learn a work ethic, and it can draw a family together in ways never fathomed by small business owners. Talk to your accountant, and get your kids to work for you before it's too late.