If you’re a business owner and a parent, and you hire your children this summer, you would be able to obtain tax breaks and other non tax benefits.
Your kid could gain on-the-job experience, spend time with you, save for college, and learn how to manage money. And you may be able to:
- It would shift your high-taxed income into tax-free or low-taxed income,
- Realize payroll tax savings (depending on the child’s age, earnings, and how your business is organized), and
- Enable retirement planning services and contributions for your children.
Your child has to have a legitimate job
If you hire your child to work for your business, you would get a business tax deduction for employee wage expenses. In turn, the deduction would reduce your federal income tax bill, your self-employment tax bill (if applicable), and your state income tax bill (if applicable). However, in order for your business to deduct the earnings as a business expense, the work performed by your child would need to be legitimate and your child’s earnings would need to be reasonable and comply with child labor law.
For example, let’s say you operate as a sole proprietor and you’re in the 37% tax bracket. You hire your 16-year-old child to help with office work on a full-time basis during the summer, and part-time into the fall. Your child’s earnings are $10,000 during 2021 and they would not have any other earnings.
You would save $3,700 (37% of $10,000) in income taxes at no tax cost to your child, who can use her 2021 $12,550 standard deduction to completely shelter their earnings.
Your family taxes are cut even if your child’s earnings exceed their standard deduction. Why? The unsheltered earnings will be taxed to your child beginning at a rate of 10%, instead of being taxed at your higher rate.
How payroll taxes might be saved
If your business isn’t incorporated, your child’s earnings would be exempt from Social Security, Medicare and FUTA taxes if certain conditions are met. Your child would need to be under age 18 for this to apply (or under age 21 in the case of the FUTA tax exemption). Contact us to know how this works if you need to.
Be aware that there would be no FICA or FUTA exemption for employing a child if your business is incorporated or a partnership that includes nonparent partners. And payments for the services of your child would be subject to income tax withholding, regardless of age, no matter what type of business or entity you operate.
Begin saving for your retirement
Your business also would be able to provide your child with retirement benefits, depending on the type of plan your business has, and how it defines qualifying employees. And because your child has earnings from his or her job, he can contribute to a traditional IRA or Roth IRA and begin to build a nest egg. For the 2021 tax year, a working child can contribute the lesser of his or her earned income, or $6,000, to an IRA or a Roth.
Keep accurate records of your child’s work and earnings
As you can agree, hiring your child as an employee would be a tax-smart idea.
Be sure to know you would need to keep the same information and records as you would for other employees to substantiate the hours worked and duties performed by your child (such as timesheets and job descriptions). Issue your child a Form W-2. Contact us if you have questions about how these rules apply to your situation.