Tax Advantages of Employing Your Kids
Do you run a small business? Got kids under 18? Now is the time to put them on the payroll. Employing your kids is a winning triple play that benefits your children, your business, and your family’s financial wellbeing. Discover the tax advantages of employing your kids, then see 4 must-follow tips if you put the kids to work!
Benefit #1) For the Kids: Tax Free Income and Retirement Planning
Most parents pay their children an allowance. But a standard allowance comes out of your after-tax income. By employing your kids to perform work for your business, paying your children now becomes a tax advantage. Here’s how it works:
While the Tax Cuts and Jobs Act TCJA) eliminated the ability to claim personal itemized deductions after December 31st, 2017, the TCJA now gives each taxpayer an automatic $12,000 standard deduction.
If you pay each child a salary of $12,000 or less, the child will not pay any tax on that income. If the wages are over $12,000? Yes, taxes must be paid on the surplus income, but it’s at the reduced rates set by the TCJA.
The smartest thing to do is to put that income into a Roth IRA, so it’s truly tax-free income that sets the child up for retirement. Employing your kids – then investing their income – is a chance to teach them about compounding interest and why earlier is better when it comes to putting aside retirement cash.
Benefit #2) For Your Business: Serious Tax Savings
If you are a sole proprietorship or LLC that reports business earnings on a personal tax return (on form 1040 of a Schedule C), you can deduct the wages you pay your child.
But it gets even better. When you employ your own children, the IRS states that your business and your child are both exempt from paying payroll taxes (also known as FICA taxes which include Social Security and Medicare) – as long as your child is under 18 years old. The current FICA tax rate is 7.65% on the first $128,400 earned by the business.
Here’s an Example: Over $8,500 in Tax Savings
Your small business earns $140,000 in 2018. You employ 2 of your children and pay them each $8,000 in wages ($16,000 total). Neither your business or your children are required to pay any FICA taxes. This instantly saves your business and your family $2,448 total.
You would deduct the $16,000 in wages, bringing your qualified business income (QBI) that is subject to tax, down to $124,000. For other ways to reduce your QBI, see this helpful article. Based on the TCJA tax rates, that $16,000 wage deduction yields about $6,000 in tax savings.
Overall, by employing your kids, you benefit from a tax advantage of about $8,500.
Benefit #3) For the Family: It’s a Smart Move Overall
So, by employing your kids, you’re reducing your business’s taxable income and therefore saving money on your 2018 taxes. At the same time, your kids are not paying any federal taxes on their income up to $12,000 per child. Finally, you’re helping your children put tax-free money aside for their retirement. See why employing your kids is a win-win-win?
S Corporations Benefit, Too
If you’ve structured your business as an S-Corp (LINK), you still must pay FICA taxes on the wages you pay any employee: your child or otherwise. When employing your kids, the children must also pay FICA taxes. However, your S-Corp can still deduct the wages paid. And if your children are each paid $12,000 or less, they do not have to pay any federal income tax. So, this is still a “win” from a tax posture perspective.
Employing Your Kids: 4 Key Tips to Keep the IRS Happy
Toddlers Need Not Apply
Unlike child labor laws – that require children to be a set age before working – there is no minimum age requirement when employing your kids. The only caveat: the child must be under 18. However, hiring a 5-year-old child to file paperwork is going to raise a few eyebrows at the IRS (and raise the risk of an audit).
Another red flag for the IRS? Paying your child inflated wages. Little Johnny shouldn’t be earning $150 an hour for stamping envelopes or stocking shelves. In the eyes of the IRS, employing your kids means they should be paid reasonable wages.
Washing Dishes? Yardwork? No and No
The IRS is also very clear that the work performed for your business must be necessary…for the business – not the family’s personal life. The lines can become blurry for home-based businesses. Sure, employing your kids to do the laundry will save Dad time he can now spend on the business. But that’s not a business-related task. An easy test: if the employee wasn’t in the family, would you ask him or her to perform the task?
Timesheets for the Win
Remember, this isn’t an allowance – it’s work. Pay your child with a check, on a regular schedule, just like you would pay any other employee.
Most importantly, create a timesheet. The golden rule in business tax best practices: document, document, document. When employing your kids, ask them to track their time by the hour: they should note what task they performed. If the IRS decides to audit your business, you’ll be ready with proof that your children truly did perform work for your business.
To take advantage of the TCJA’s new $12,000 standard deduction, employing your kids is one of the best tax saving strategies you can put into play. If you have any questions about how employing your kids will impact your tax return for 2018, contact us today.