There are a lot of tax advantages to child labor! So here’s an idea for those running a small business as a sole proprietorship or husband-wife partnership or even a farm or rental property investors. Consider hiring your under-age-18 child as a bona fide employee. It can be part-time or full-time. 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 blow up in your face. I bet many kids have been helping their parents over the summer that should receive a paycheck for their summer work to use this tax loophole.
The Tax-Saving Benefits
Children’s wages are exempt from all federal employment taxes (social security, medicare taxes and federal unemployment tax as long as the child is under 18 years old.
Even better, your employee-child can use his or her standard deduction to shelter up to $6,300 of 2015 wages from federal income tax. So your kid will probably owe zero federal employment taxes and zero federal income tax on the first $6,300 of his or her 2015 wages.
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. Hire your child and you keep it in the family tax -free. Plus, you can still claim your children on your tax return as a dependent and take the exemption.
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. Jobs children are great at include filing, cleaning, running business errands, data input, yard maintenance, farm labor, etc. I bet if you put your mind to it there are several things your kids could do to help out and take advantage of this tax loophole.
Create an Even Bigger Tax Loophole by Setting up a Roth Retirement Savings Account
An incredible side benefit to this strategy is that once your kids have “earned” income they can now contribute to a Roth 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.
Add Up The Benefits
Let’s add up the benefits of hiring your under-age-18 child:
• No federal employment taxes on the kid’s wages.
• No federal income tax on the first $6,300 of the kid’s 2015 wages.
• Valuable business deductions for you.
• Valuable work experience for the kid.
• Money is kept in the family instead of going to outsiders.
• Your child can set aside some or all of the wages and invest the money. Hopefully, that cash stash can eventually be used to help pay for college, which means you won’t have to shell out as much.
• After your child reaches age 18, Social Security and Medicare taxes will be due on the wages. However no FUTA tax is due until age 21. Your child’s standard deduction will still shelter a good chunk of the wages from the federal income tax. And you’ll still collect a nice business write-off.
Key Point: The kid’s wages must be reasonable for the work performed. So this idea works best with teenage kids who can be assigned meaningful duties. You should keep the same business records that you would for any other employee to substantiate hours worked and duties performed. Your business should issue your child a Form W-2 for each year’s wages, just like you would for any other employee.
The Bottom Line
If your small business has meaningful work that could be performed by one or more of your children, the hire-the-kid strategy is virtually a no-brainer. Go for it!