Should you give your children a job in your company?
Have you thought about putting your kids to work in your business? Employing your own children is a seldom-used tax-saving strategy that can also help you save for your child’s college education or retirement.
Business owners who pay their own children who are under age 18 are generally not required to withhold payroll taxes such a FUTA, SUTA, or FICA. They also may not need to withhold any federal income taxes on their child’s behalf, since no tax is assessed on the first $6,300 of earned income (the standard deduction for 2016). As long as earnings are below the standard deduction, the child won’t have to file their own tax return (provided they don’t have any other income) and the parent can still claim them as a dependent. Paying a child wages from the business also won’t subject them to kiddie tax rules since the kiddie tax is only applicable to “unearned” income such as interest, dividends, and capital gains.
Keep in mind that the option to not withhold payroll taxes applies only to Sole Proprietorships and LLCs taxed as partnerships. It does NOT apply to S-Corporations or C-Corporations.
The IRS is on the lookout for taxpayers who claim the tax benefits of hiring their children without actually putting them to work, so you’ll need to maintain documentation to support the deduction. The kids will have to perform legitimate work for the business. You can’t hire them to do personal chores or issue a paycheck while they are at home watching TV. The work they perform will need to be “ordinary and necessary” for your business. That might include yard work on business property, answering phones, stuffing envelopes, cleaning the office or working on the company website and social media accounts.
You’ll also need to show records for hours worked, which is easily tracked via time sheets or time cards. The rate of pay must be reasonable as well. You can’t pay your child $50 an hour to stuff envelopes in order to maximize the tax deduction. Pay your child no more than what a stranger would make performing the same work.
If your deduction is challenged by the IRS, they will also consider the age of the child. The IRS has accepted children as young as seven as employees of a business but probably won’t accept that children younger than seven are performing useful work for your business.
Be sure to complete all of the normal paperwork that you would for any other employee, such as a Form W-4, USCIS Form I-9, and issue a W-2 at year end. To further support the deduction, pay your children by check, not cash, or by making other purchases on their behalf. One taxpayer found her deduction disallowed because she paid her children in pizza and tutoring services. As always, it’s a good idea to consult a tax professional to make sure you’re accounting for everything correctly.
Want to make your tax savings even more valuable? Consider depositing their wages into a Roth IRA. Roth IRA contributions can be pulled out later for college expenses tax- and penalty-free, or kept in the account and withdrawn tax-free in retirement.