Wondering if there's another way out there to save money on income taxes? If you're like many small-business owners I know, you're ignoring a tax-saving strategy that's eating food at your dinner table -- and maybe plotting how to stay out late with friends.
Putting your children to work in your business, even if only for the summer, is one of the most underutilized tax-saving strategies today. I've found that many business owners simply don't realize placing children under 18 on the payroll, or even grandchildren or adult children, is an excellent strategy to minimize tax liability.
Beyond the tax savings, you'll teach your kids a work ethic, money-management skills and a concept of entrepreneurship.
So get them involved in the business.
Related: Is the Health Care Tax Credit a Dud?
By placing them on your payroll, you'll save money on taxes in two ways:
- You don't have to withhold any income taxes or payroll taxes if you're paying your children under 18 to work for you. This also applies to workers' compensation insurance programs. You don't need to cover your children -- the assumption being that your children won't sue you for getting hurt on the job. They're probably on your health-insurance plan anyway, so you already have them covered in case of injury.
- All of us including our children don't pay federal income taxes on the first $5,950 of income this year. It's called the Standard Deduction. Pay someone who isn't a relative to work for you, and they take that $5,950 of tax-free income home with them. Hire your child, and you keep it in the family. Plus, you can still claim your children on your tax return as a dependent and take the exemption, even the child tax credit.
Pay your children for services they perform for your business, and you'll actually generate an expense for your income taxes by pushing income to your children.
I want to be crystal clear that I'm not advocating you create some sham job for your kids to shield income from taxes. They have to be legitimately involved in the business. If the Internal Revenue Service audits you, you'll have to produce records of their time worked, and you'll have to demonstrate that the wages paid were reasonable. No $25 an hour store-clerk jobs allowed.
There are specific procedures you need to follow if you hire your children, and it is important you follow the right procedure or it could backfire on you.
- The IRS allows any sole proprietorship or partnership (LLC) that is wholly owned by a child's parents to pay wages to children under age 18 without having to withhold the payroll taxes. However, if you have an S- or a C-corporation you do not receive this benefit of avoiding payroll taxes when paying your children. If you pay your children out of a corporation, you'll have to withhold payroll taxes.
- To sidestep the problem, I recommend you pay children out of a family management company paid a management fee from the corporation, or simply pay them out of a sole-proprietorship or LLC with independent income and operations.
- Some business owners ask: "What about the "kiddie tax? Aren't the kids going to end up paying taxes on their income at our rates (the parent's) anyway?" The answer is no. The kiddie tax applies only to unearned or "portfolio" income.
- Do not hire your children simply to do "family chores." The chores will not qualify as a valid deduction, and you could set yourself up for an audit.
- If you are paying children over age 18 or grandchildren, you have the option of treating them as either as subcontractors or employees. You will have to withhold FICA and other typical payroll fees if they are employees.
I have seen this strategy not only save clients thousands of dollars in taxes, but literally change the lives of their families. Children begin to learn a work ethic, and it can draw a family together in ways never fathomed by small business owners. Talk to your accountant, and get your kids to work for you before it's too late.