If you own an unincorporated business, such as a sole proprietorship, hiring your children could cut your tax bill and give your children a great opportunity to save money. According to IRS publication 15, “Payments for the services of a child under age 18 who works for his or her parent in a trade or business are not subject to social security and Medicare taxes if the trade or business is a sole proprietorship or a partnership in which each partner is a parent of the child.” These payments are also generally not subject to federal unemployment taxes or income tax withholding. This means that you can write them a paycheck and not have to withhold taxes…
This strategy has several advantages: (1) it allows you to pass income to someone in a lower bracket (if they make less than the standard deduction, they will likely pay zero tax), (2) it allows the child to have earned income for a Roth IRA (for children with no taxable income, a traditional IRA would not make sense), (3) it enables you to pass income to children without gift tax implications and (4) it gives children valuable work experience.
Let’s suppose that Jane, an attorney, hires her 14-year-old son to clean her office. She pays him $10 / hour for 10 hours a week or $5,000 each per year. This creates a $5,000 deduction for Jane, potentially saving her thousands in taxes. If this was the only money her son earned during the year, he would not need to pay taxes on it because $5,000 is less than the standard deduction.
As with any tax strategy, you should seek professional advice before you implement it. Keep in mind that states have strict child-labor laws, many of which can still apply when you hire your children. Also remember to pay a reasonable wage. In the example above, if Jane decided to pay her son $100 / hour to clean her office, the IRS could disallow the deduction in an audit. If, however, Jane is careful about child labor laws, pays a reasonable wage, and documents her son’s work and schedule, this deduction should hold up under IRS examination and cut Jane’s tax bill.
If you would like help in implementing this tax strategy or would like to find out about other tax strategies, give PorterKinney a call at 713-7300.