As a small business owner you shouldn’t overlook the opportunity to provide your children with work experience. Also, there may be some tax advantages to hiring them.
Hiring your child under the age of 18 can save on taxes. The tax code provides that “service performed by a child under the age of 18 in the employ of his father or mother”1 is generally not subject to Social Security taxes. This savings can add up since businesses pay both the employer’s share and half of the employee’s share, which can add up to 15.3%, not to mention that your child won’t have to pay Social Security taxes on earnings.Regardless of your child’s age, the income tax savings can be signi cant. Let’s say your business is subject to a marginal income tax rate of 39.6%, not including state income taxes. Hiring your child can save you 39.6 cents for each dollar paid to your child, assuming wages are “reasonable” and deductible.
Consider establishing a Roth IRA for your child. While Roth IRA contributions are made with after-tax dollars, this may be moot if your child’s income is below the standard deduction; thus, your child pays no income taxes.
Another option may be establishing a traditional IRA. Traditional IRA contributions are made with pre-tax dollars, although there are deductibility phase-outs depending on a taxpayer’s AGI, which should generally be inapplicable to your child. Distributions from a traditional IRA are taxable, but since distributions don’t have to be taken until your child reaches age 70 ½, there are many years for the IRA to grow in value and provide retirement savings for your child. Depending on your child’s income tax situation, a Roth IRA may be a better option.
Pay for Your Child’s Education
If your business has a written educational assistance plan, it may be able to deduct up to $5,250 for your child’s education. What’s more, your employed child can exclude this amount from income. There are anti-discrimination rules associated with this plan, so other employees may have to be offered this benefit. Additionally, no more than 5% of the total benefits paid each year under the plan can benefit the owners, their spouses, or their dependents.
Beware of the “Kiddie” Tax
To discourage parents from shifting unearned income to their children who are subject to lower income tax rates, Congress enacted the “Kiddie” tax. It imposes a parent’s marginal income tax rate on a child’s unearned income (e.g., interest and dividends) for children under age 18, as well as for children who are under age 24 and are full-time students without earned income exceeding half of their support. If you hire your child, you can help your child’s earned income exceed more than half of his or her support and avoid the “Kiddie” tax on unearned income. Consulting with a tax professional is advisable.