As a business owner, you should be aware that you can save
family income and payroll taxes by putting junior family members on the
payroll. You may be able to turn high-taxed income into tax-free or low-taxed
income, achieve social security tax savings (depending on how your business is
organized), and even make retirement plan contributions for your child.
In addition, employing a child age 18 (or if a full-time
student, age 19-23) may be a way to save taxes on the child's unearned income,
as explained below.
You can turn some of your high-taxed income into tax-free or
low-taxed income by shifting some of your business earnings to a child as wages
for services performed by him or her. In order for your business to deduct the
wages as a business expense, the work done by the child must be legitimate and
the child's salary must be reasonable.
For example, suppose a business owner operating as a sole
proprietor is in the 37% tax bracket. He hires his 17-year-old daughter to help
with office work full-time during the summer and part-time into the fall. She
earns $11,100 during the year (and has no other earnings).
The business owner saves $4,107 (37% of $11,100) in income taxes
at no tax cost to his daughter, who can use her $12,000 standard deduction for
2018 to completely shelter her earnings. The business owner could save an
additional $2,035 in taxes if he could keep his daughter on the payroll longer
and pay her an additional $5,500. She could shelter the additional income from
tax by making a tax-deductible contribution to her own IRA.
Family taxes are cut even if the child's earnings exceed his or
her standard deduction and IRA deduction. That's because the unsheltered
earnings will be taxed to the child beginning at a rate of 10%, instead of
being taxed at the parent's higher rate.
Keep in mind that bracket-shifting works even for a child who is
subject to the kiddie tax, which causes the child's investment income in excess
of $2,100 for 2018 to be taxed at the trust rates. The kiddie tax has no impact
on the child's wages and other earned income.
The kiddie tax doesn't apply to a child who is age 18 or a
full-time student age 19 through 23, if the child's earned income for the year
exceeds one-half of his or her support. Thus, employing a child age 18 or a full-time
student age 19-23 could also help to avoid the kiddie tax on his or her
unearned income.
For children under age 18, there's no earned income escape hatch
from the kiddie tax. But in all cases, earned income can be sheltered by the
child's standard and other deductions, as noted above, and earnings in excess
of allowable deductions will be taxed at the child's low rates.
Your business probably will have to withhold federal income
taxes on your child's wages. Usually, an employee can claim exempt status if he
or she had no federal income tax liability for last year, and expects to have
none for this year. However, exemption from withholding can't be claimed if (1)
the employee's income exceeds $1,050 for 2018 and (2) the employee can be
claimed as a dependent on someone else's return. Keep in mind that your child
probably will get a refund for part or all of the withheld tax when he or she
files a return for the year.
If your business isn't incorporated, you can also save some
self-employment (i.e., social security) tax dollars by shifting some of your
earnings to a child. That's because services performed by a child under the age
of 18 while employed by a parent isn't considered employment for FICA tax
purposes.
A similar but more liberal exemption applies for FUTA
(unemployment) tax, which exempts earnings paid to a child under age 21 while
employed by his or her parent. The FICA and FUTA exemptions also apply if a
child is employed by a partnership consisting solely of his parents.
Note that there’s no FICA or FUTA exemption for employing a
child if your business is incorporated or a partnership that includes
non-parent partners. However, there’s no extra cost to your business if you’re
paying a child for work you’d pay someone else to do, anyway.
Your business also may be able to provide your child with
retirement benefits, depending on the type of plan it has and how it defines
qualifying employees. For example, if it has a simplified employee pension
(SEP), a contribution can be made for the child up to 25% of his or her
earnings but the contribution can't exceed $55,000 for 2018. The child's
participation in the SEP won't prevent the child from making tax-deductible IRA
contributions as long as adjusted gross income (computed in a special way) is
below the level ($63,000 in 2018) at which deductions for IRA contributions
begin to be disallowed.
If you have any questions about how these rules apply to your
particular situation, please don't hesitate to contact us.
