As a small business owner, you always look for legitimate ways to save on taxes while growing your business, and having children aged 7 to 17 grants you a distinct advantage in accomplishing that.
Employing your children grants them valuable professional experience and presents substantial tax benefits for your partnership or sole proprietorship.
Let’s explore how this strategy works and how you can implement it effectively.
Understanding the Tax Benefits
When you hire your children, you can shift income from your higher tax bracket to their lower one.
Here’s why that’s beneficial:
1. Income Shifting:
Children employed by their parents’ business can earn up to the standard tax-free deduction amount ($14,600 for 2024). This has the potential to decrease one’s taxable income and subsequently lower one’s tax bracket.
2. Employment Tax Savings:
If your business is a sole proprietorship or a partnership where the only partners are the child’s parents, wages paid to your children under 18 are exempt from Social Security and Medicare taxes. Additionally, wages paid to your children under 21 are exempt from federal unemployment taxes.
3. Business Expense Deductions:
The wages you pay your children are fully deductible as a business expense, which lowers your business’s taxable income.
4. Savings for retirement:
You can also help your kids start saving early by putting money into a Roth IRA up to the annual contribution limit or the amount they make.
Executing the Strategy
To ensure compliance with IRS rules and to reap the full benefits of this strategy, follow these steps:
1. Legitimate Employment:
Your children must be performing appropriate work for their age. This could include filing, cleaning the office, or assisting with social media.
2. Proper Record-Keeping:
Write in detail what your kids did for work, including job descriptions, hours worked, and duties performed.
3. Reasonable Wages:
Pay your children a reasonable wage for their work. This means their pay should be about the same as what you would pay someone unrelated to them for the same job.
4. Formal Payroll:
Put your children on the payroll and issue them a W-2 like any other employee. This formalizes the employment relationship.
5. Separate Bank Accounts:
It is advisable to establish separate bank accounts for your children, in which you can deposit their wages. This demonstrates that the salaries are controlled and used by the child.
6. Compliance with Child Labor Laws:
Ensure you comply with federal and state child labor laws regarding the number of hours they can work, especially during school periods.
Conclusion
Hiring your children in your partnership or sole proprietorship can be a win-win situation. Your business can save money on taxes, and your kids can get work experience and start saving money.
However, it’s crucial to treat the employment relationship professionally and comply with all tax and labor laws. Consider consulting with a tax professional to help you set up this strategy correctly and maximize your tax benefits.