School’s out, and that can mean opportunities for your business. If you have a child interested in your work, consider hiring them for the summer. Not only does it give your son or daughter a great experience, but you can both reap the tax benefits too!
Benefits for Your Child
Depending on your business structure, your child might get special tax breaks come filing season. These entities include:
- Sole proprietorship,
- Partnership owned by both spouses,
- Single-member LLC that’s treated as a sole proprietorship for tax purposes, or
- LLC that’s treated as a partnership owned by both spouses.
Hiring your child if you operate one of these types of businesses is a smart tax more because:
- Your child’s wages are not subject to Social Security, Medicare, or Federal unemployment (FUTA) tax until the employee-child reaches age 21, which means significant tax savings for your business.
- If your child is considered a dependent, their standard deduction for 2024 wages shields up to $14,600 from federal income tax. Depending on their rate of pay, this might mean a significant portion of their summer earnings won’t be taxed at all.
Benefits for Your Business
When hiring your child, you get a business tax deduction for employee wage expense and this deduction reduces your federal income tax bill, self-employment tax bill, as well as your state income tax bill (where applicable).
It is important to note that there are different rules for corporations:
- C and S corporations: Your child’s wages are subject to Social Security, Medicare and FUTA taxes, like any other employee but you can deduct their wages as a business expense on your corporation’s tax return. In turn, your child can shelter the wages from federal income tax with the $14,600 standard deduction for single filers.
Traditional and Roth IRAs
Regardless of the type of business you operate, your child is eligible to contribute to an IRA or Roth IRA. For Roth IRAs, contributions are made with after-tax dollars meaning that taxes get paid upfront. For accounts that have been open for more than five years, the account owner, upon turning age 59½, can withdraw the contributions and earnings without paying federal income tax.
Contributions to a traditional IRA, on the other hand, are deductible and subject to income limits. Deductible contributions to a traditional IRA lower the employee-child’s taxable income.
As such, contributing to a Roth IRA is a better idea for a child than contributing to a traditional IRA. First, your child probably won’t get meaningful write-offs by contributing to a traditional IRA as their standard deduction shelters to $14,600 of 2024 earned income, and additional income will likely be taxed at very low rates.
A further benefit is that, your child can withdraw all or part of the annual Roth contributions for any reason without federal income tax or penalty. Of course, the best strategy is to leave as much of the Roth balance untouched until retirement so it can accumulate a larger tax-free amount.
The only tax law requirement for your child when making an annual Roth IRA contribution is having earned income for the year that at least equals what’s contributed for that year, regardless of age. For 2024, your child can contribute to an IRA or Roth IRA the lesser of their earned income or $7,000.
Even modest Roth contributions add up over time. If your child contributes $1,000 to a Roth IRA each year for four years, the account would be worth about $32,000 in 45 years - assuming a 5% annual rate of return. If you assume an 8% return, the account would be worth more than three times that amount!
While hiring your child can be a tax-smart idea, you need to ensure that their wages are reasonable for the work performed. Be sure to maintain the same records as you would for any other employee to ensure the hours worked and duties performed by using timesheets, job descriptions and W-2 forms.
Reach out to a Smolin Advisor with any questions you have about employing your child at your small business.