If you’re a business owner and you hire your children or grandchildren for a summer job, you can qualify for tax breaks and other nontax benefits. The kids can gain on-the-job experience, save for college, and learn money management skills.
In addition, you might be able to:
- shift your high-taxed income into tax-free or low-taxed income
- realize payroll tax savings, depending on the child’s age and how your business is organized
- enable retirement plan contributions for the children
It must be a real job
When you hire your child, you get a business tax deduction for employee wage expenses. In turn, the deduction reduces your federal income tax bill, your self-employment tax bill (if applicable), and your state income tax bill (if applicable). However, for your business to deduct the wages as a business expense, the work performed by the child must be legitimate, and the child’s salary must be reasonable.
For example, let’s say a business owner operates as a sole proprietor and is in the 37% tax bracket. He hires his 16-year-old daughter to help with office work full-time during the summer and part-time in the fall. The daughter earns $10,000 during 2019 and doesn’t have any other earnings.
The business owner saves $3,700 (37% of $10,000) in income taxes at no tax cost to his daughter, who can use her 2019 standard deduction of $12,200 to completely shelter her earnings.
The family’s taxes are cut even if the daughter’s earnings exceed her standard deduction — that’s because the unsheltered earnings will be taxed to the daughter beginning at a rate of 10% instead of being taxed at her father’s higher rate.
Your business also may be able to provide your child with retirement benefits, depending on the type of plan you have 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. For the 2018 tax year, a working child could contribute the lesser of his or her earned income, or $6,000 to an IRA or a Roth.
Raising tax-smart children
Hiring your child can be a tax-saving idea but be sure to keep the same records you would keep for other employees, and substantiate the hours worked and duties performed (such as timesheets and job descriptions). And issue your child a Form W-2.
If you have any questions about how these rules apply to your situation, don’t hesitate to contact a KraftCPAs tax representative.