Tax Tip Tuesday: Make Life Tax Deductible

Tax Tip Tuesday

As any parent or grandparent knows, kids can be pretty taxing in more ways than one.  But what if there’s more than one way to utilize those little taxing individuals to actually SAVE you tax dollars?  Now your ears have perked up!

Putting your children to work in your business, even if only for the summer, is one of the most underutilized tax-saving strategies today.  Many business owners simply don’t realize that placing children, or even grandchildren or adult children, on payroll is an excellent strategy to minimize tax liability.

Putting the kids on the payroll

Here are three ways to save money on your taxes when you place kids on your payroll in your unincorporated business:

  1. You do not have to withhold any income taxes or payroll taxes if you are paying your children under 18 to work for you provided you wholly own the business.  There’s no requirement to pay into Medicare, Social Security, federal or state unemployment taxes either.  You also do not need to pay any unemployment tax on their wages.  You will issue a W-2 with just box 1, wages, completed.
  • And because the standard deduction precludes anyone from paying taxes on the first $12,550 of income this year, you save there, too. Plus, you can still claim your children on your tax return as a dependent, including the child tax credit.
  • By paying your children for services they perform for your business, you’ll generate a deductible business expense, categorized as payroll, on your business income taxes, reducing your business income by the amount you pay to your children. 

However, if your business is incorporated, such as an S or C Corporation, the rules are vastly different as follows:

  • You do not receive the benefit of avoiding payroll taxes when paying your children. If you pay your children out of a corporation, you’ll have to withhold payroll taxes.  An option is to pay children out of a family management company that is paid a management fee from the corporation.  In either situation, you will need to pay the normal payroll taxes.
  • If you are paying children over age 18 or grandchildren, you have the option of treating them as either as subcontractors or employees. You will have to withhold FICA and other typical payroll fees if they are employees. If you treat them as a subcontractor, they will need to file a tax return and pay the SS/Medicare tax as part of their tax return.

Guideline for hiring your children

Beware, however, that there are specific guidelines established by the IRS before hiring your children.  Not adhering to these rules could have an adverse effect.  Here’s a few points to be aware of:

  • 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.
  • This does not work with a child under the age 7.  At that age, IRS has constantly won in Tax Court that it is not meaningful work.
  • Deposit the payment in a bank account that is in the child’s name.
  • Keep track of the hours worked and the duties completed.  We are looking at a reasonable wage for the type of work and time that the child works.

Often people are concerned about their child under 18 being required to file a tax return.  Remember, that as long as they earn up to or less than the standard deduction for that tax year, a tax return is not required to be filed.

Tax Strategies

But what about the kiddie tax? Are the kids going to be required to pay taxes on their income at the parents’ rate? Nope!  You’re safe again.  The kiddie tax is about your child’s unearned income from a “portfolio” not from employment income. 

Be sure to implement these strategies before December 31st, as tax strategies should go into place while you’re in the year of making income.

Keep in mind that your child must be a legitimate worker who does things for your business that is ordinary and necessary in order to take advantage of these tax strategies. Do not create a bogus job, because if the IRS audits you, you will be required to produce records of time worked as well as demonstrate that the wages paid were reasonable.  Essentially the same rate of pay you would pay a non-family member.

This tax savings strategy has saved clients thousands of dollars in taxes. In essence, this tax savings strategy for unincorporated businesses provides the opportunity to make life deductible.  For example:

  • Savings Account – You are keeping that income in the family by creating a savings account for the employed child with tax-free money.
  • Deductible Life Expenses – You can use the tax-free wages paid to your child to pay for things that are not the basic support of the child such as summer camps, dance or horseback riding lessons, travel sports teams, etc.  Simply hire your kid in the business, follow the IRS rules, deposit wages in the child’s bank account and then the child pays for camp/lessons/team out of that bank account. 

Of course, outside of the financial benefits, this strategy also helps children begin to learn a work ethic, exposes them to an entrepreneurial spirit and provides invaluable time with family.

Sharing this tax savings strategy is not all-inclusive in all situations.  Therefore, it is always best to meet with a tax strategist, like me, before blindly implementing a strategy without all of the details.  If you are interested in this strategy and others to make your life deductible, check out our Tax Planning webpage or Contact Us at 301-714-2071.