One often overlooked tax saving strategy is to hire your children to work for your business, assuming they can legally work (e.g., age, permits, etc.). This can be a great opportunity to save money. Not only are your children’s wages deductible as a business expense, but there are also opportunities to save money on income and payroll taxes under a strategy called income shifting.
How This Can Save You Money
If you hire your children to work for your business, you may deduct their wages as a business expense. This reduces the tax that could be due on your business income and gives you the opportunity to shift income into a zero percent tax bracket. If your child earns less than the standard deduction for the year, no federal income tax will be due. For 2019, that standard deduction is $12,000 for a single taxpayer. This means your child can earn up to $12,000 this year and owe no federal tax on that income. If you are currently in the highest tax bracket, you could save up to 37% in federal taxes on this amount.
Your child may be able to earn even more money tax free by putting money away towards a retirement plan. The additional savings available hinges on a few factors, which may include their age, hours of service, and types of plans available.
As shown in the tax bracket below, your child will likely pay tax at much lower rates than you, even if he or she earns more than the standard deduction in the year:
|2019 Individual Tax Brackets|
|Rate||Single||Married, Filing Jointly|
|10%||$0 to $9,700||$0 to $19,400|
|12%||$9,701 to $39,475||$19,401 to $78,950|
|22%||$39,476 to $84,200||$78,951 to $168,400|
|24%||$84,201 to $160,725||$168,401 to $321,450|
|32%||$160,726 to $204,100||$321,451 to $408,200|
|35%||204,101 to $510,300||$408,201 to $612,350|
|37%||$510,301 and up||$612,351 and up|
In addition to income tax savings opportunities, you may be able to save on payroll taxes. If your child is under age 18, you do not have to withhold or pay any Social Security or Medicare tax on their wages, nor pay any federal unemployment tax, if you are a sole proprietorship or in a partnership where each partner is the parent of the child. If your business is one of these types and your child is between ages 18 and 20, the child’s wages are not subject to federal unemployment tax, though Social Security and Medicare taxes apply. Check your particular state’s unemployment rules, as those may vary.
Your children’s wages are still subject to income tax withholding requirements. Their wages are also still subject to Social Security, Medicare, and federal unemployment taxes if your business is a corporation, a partnership with other partners that are not a parent of the child, or an estate.
Of course, there are substantial tax benefits available for hiring your children. However, several key guidelines must be followed to comply with Internal Revenue Service (IRS) regulations. First, your child must be an employee getting paid to perform services that are ordinary and necessary for your business. The wages your child receives must also be for services they actually performed, and their compensation for those services must be reasonable. Lastly, income tax filing requirements must be followed for your children and can vary depending on factors such as other earned income, unearned income, and more.
If you would like to discuss the strategies discussed above or more methods to save money by hiring your children or family members, please contact Angela M. Chaney, CPA at 240.364.2656.