Hiring Your Kids To Work For You Can Result in Significant Tax Savings.
Do you occasionally have your teenage children or grandchildren helping you at the office on weekends, after school, or during their summer break? If so, you may want to consider putting them onto payroll. If you already have payroll set up for your company, adding your children should not be that big of a hassle. (However, if they just work once in a while, you might want to bypass the formalities and just add something to their allowance.) In addition, there is the added benefit of teaching your children a good work ethic, and understanding the value of money.
Let's review an example of the amount of potential tax savings;
- Income Tax
- Let's take an example, your federal tax rate is 25%, and your state tax rate is 7% for a combined 32%.
- In comparison, if you hire your child/grandchild and you do the accounting right, they will pay no federal income taxes on the first $12,550 they earn in 2021. They will most likely pay very little state income tax, and even if they end up earning more, the federal and state tax rates will be relatively low.
- In this example, paying your child $12,550 saved you approximately $4,000 in income taxes.
- But wait, there is more, you can potentially save on social security and other tax as well!
- If your business operates as a sole practitioner (also known as a schedule C), or if you and your spouse have a partnership (or an LLC taxed as a partnership) and employ your children, you may save even more taxes. If the kids are minors, you won't need to pay, and the kids won't need to pay Social Security, Medicare, or FUTA taxes on their wages. Social security & Medicare is another 15.3%, so combined with the 32% savings, we're up to a total savings of close to $6,000!
Keep in mind that this cannot be utilized if there is an outside partner, or if the business is a corporation.
Be reasonable and make sure to have supporting documentation
Now that you understand the value of hiring your children, be sure of the following;
- The pay is reasonable and not excessive. Per the regulations, for any wage to be deductible, the amount paid needs to be reasonable. To be on the safe side, make sure that you pay the going salary. Don't pay more than you would to an unrelated party who would have filled the job. If you never had anyone in that position, ask around. An excessive salary is sure to raise a red flag. Tip to play it safe, pay your kids the minimum wage.
- Ensure that the children are suitable for the job
- Examples of jobs that are not suitable for kids – Fieldwork. State law requires anyone working in a dangerous industry to be at least 17, so if you run an auto mechanic shop, you can't hire your 12-year old to help you.
- Examples of suitable jobs – light office work. Your high school child can help you clean the office, stuff envelopes, data entry, light bookkeeping jobs. Etc.
- Please check here the New York regulation regarding youth employment.
Keep in mind, if audited, the IRS is quick to investigate family members' payroll. If it's clearly not possible the child could have performed the work as claimed, the IRS will disallow the payments. Document everything. Keep a log of days and hours worked, what was done, etc.
Clearly, we've made it simpler than in real life. Be sure to discuss this with your accountant if this may apply to you.