Tax breaks and other nontax benefits are available for business owners who hire their children this summer. By hiring your child, you may be able to:
- Realize payroll tax savings, depending on how your business is organized and your child’s age
- Convert high-taxed income into income that is low-taxed or tax-free
- Enable retirement plan contributions to be made for or by your children
In addition, your children will be able to spend time with you, save for college, gain job experience, and learn money-management skills.
Tax advantages to hiring your child
Business owners that hire their child receive a business tax deduction for employee wage expenses. This deduction also reduces the business owner’s federal income tax bill, state income tax bill (if applicable), and self-employment tax bill (if applicable). However, the child’s salary must be reasonable and any work performed by the child must be legitimate in order for the business to be able to deduct their wages as a business expense.
For example, say a sole proprietor in the 37% tax bracket were to hire their 17-year-old daughter on a full-time basis during the summer and part-time in the fall to help with office work.
If the daughter earns $10,000 during 2021 and doesn’t earn any other income, the owner will save 37% of $10,000 ($3,700) in income taxes at no tax cost to their daughter. In addition, their daughter can completely shelter her earnings using her 2021 $12,550 standard deduction.
And even if a child’s earnings exceed their standard deduction, the family’s taxes are still reduced, because any unsheltered earnings will be taxed to the child beginning at a rate of 10%, rather than being taxed at the parent’s higher rate.
Additional savings in payroll taxes
If an owner’s business is unincorporated and certain conditions are met, their child’s wages are exempt from Social Security, Medicare, and FUTA taxes. For this to apply, however, the child must be under the age of eighteen (or, in the case of the FUTA tax exemption, under the age of 21). For more information on these exemptions, contact us.
It’s worth noting that if a business is incorporated or structured as a partnership that includes nonparent partners, it won’t receive a FICA or FUTA exemption for employing a business owner’s child. And no matter what type of entity you operate, payments for the services of a child are subject to income tax withholding regardless of the child’s age.
Retirement savings
Business owners may also be able to provide employed children with retirement benefits depending on the type of retirement plan their business offers and how it defines qualifying employees. Since they’re receiving earnings from the job, the child can also begin to build a nest egg by contributing to a traditional IRA or Roth IRA. For earnings in 2021, a working child is allowed to contribute the lesser of $6,000 or their earned income to an IRA or a Roth.
Make sure to keep records
As you can see, there are many potential tax and nontax benefits to hiring your child. However, you’ll want to make sure to keep the same records for them as you would for other employees, including timesheets and job descriptions, so that you can substantiate the hours they worked and the duties they performed. Your child should also be issued a Form W-2. If you have any questions about how these rules might work in your situation, contact us.