Employ Your Children to Cut Taxes
You can’t have it both ways, so the saying goes. You can, however, employ members of your own family in certain circumstances. Whether your kids are minors or adults, pay them to work for your business and then deduct the expense.
Many people don’t know if it’s legal to hire their kids and grandkids. Follow my advice to reduce your personal taxes and adhere to IRS and employer requirements. As long as it’s a sincere payment for services provided and the paperwork is handled properly, paying family members is entirely morally and legally acceptable.
Young Children Save the Most on Taxes
Unless they engage in manufacturing, mining, or any other hazardous occupation designated by the Department of Labor, parents—especially those under 16—are excluded from child labor regulations. When my own kids were seven and nine years old, I hired them with ease.
You are exempt from paying Workmen’s Compensation (in most states), payroll taxes (including Social Security), and withholding income taxes until the child turns eighteen. Just remember that each employee’s payroll tax reports must be filed on a quarterly basis. Federal unemployment taxes are not due until the child turns 21.
However, if your business is a S or C Corporation, you must pay Social Security and Medicare taxes regardless of their age.
To Prevent an IRS Examination
1. The children must labor; 2. They must be paid on a regular basis; and 3. They must be paid what you would pay someone else.
4. Maintain detailed documentation
5. Issue a W-2 and file the child’s tax return at year’s end, even if there is no tax owed.
For example, a 13-year-old child received $6200.
Less: The $5,000 standard deduction for 2005; $1200 in taxable income; $120 in tax due (10% x $1200).
But for the parents: The child’s salary was $6200.
Tax Savings: $2480 ($6200 x 40%)
for the family to save $2360.
Everyone in the country is eligible for a $5000 income tax basic deduction, including your minor children. Unless you pay them more than that, they won’t be liable for any taxes. Furthermore, since they actually earned money, the “kiddie tax rules” do not apply.
When you hire adult family members, you may justify paying them more. They also qualify for approved retirement benefit programs and fringe benefits like childcare and health insurance.
Children Learn How to Manage and Save Money by Working for You
The money must be proportionate with the value of the work because the child must earn it. They still own the money even though it is being saved for schooling.
There are a number of benefits to include your children in your business that are unrelated to taxes. They are gaining practical experience, learning the importance of hard work, and perhaps even learning how to carry on the family business in the future.
If you’re considering whether or not to heed my advice, I’ve sat on both sides of the desk. I’ve given almost a thousand talks on taxes and financial planning since I left the IRS. Speaking with real estate and banking professionals across the country, I’ve found that everyone wants to know about smart strategies that generate consistent profits without putting them in hot water with taxes. One of them, in my opinion, is hiring your family.
Don’t be scared to use force. When you hire your kids, you are teaching them long-term skills. They are learning how much a dollar is worth and how hard it takes to earn it. It also makes good financial sense in the end.