Making Your Small Business a Family Business: Employing Your ChildrenBondBeebe
Posting by Sean Urbany
If you have children and also own and operate your own business, summer is a great time to implement an easy tax savings strategy: hire your children to work for you. This could have several tax benefits for both you and your children, including lowering taxable income, reducing payroll taxes, and creating opportunities to start your children’s retirement savings.
Lower Taxable Income
Paying your child wages to work for your business is a great way to shift some income and lower your family’s taxes. If the wages paid to your child are reasonable and legitimate, you can claim them as a business deduction. This will shift income from your high tax rate (potentially up to 39.6% for 2013) to your child’s lower tax rate (likely 15% or less).
For 2013, you can pay each child up to $6,100 without him or her paying any tax on the wages, as the standard deduction for a single dependent is $6,100. Wages paid over the standard deduction amount will still be taxed at a low rate: 10% on taxable income up to $8,925 and 15% on taxable income up to $36,250. In most cases, this shift in income will result in overall tax savings for your family.
Payroll Tax Savings
When you have employees in your business, you usually have to pay the associated payroll taxes: Social Security, Medicare and Federal Unemployment Tax (FUTA) at the federal level, as well as state unemployment taxes. However, if your business is unincorporated (a sole proprietorship or partnership) and your children are employees, there is an exemption for Social Security and Medicare taxes for those children if they are under the age of 18 and a FUTA exemption for those children if they are under the age of 21. If your business is incorporated, however, these payroll tax exemptions do not apply.
For wages paid to your children, there is no exemption for federal tax withholding and as such your business will most likely still be required to withhold federal taxes on these wages. However, your children will probably receive all of this money back as a refund on their tax return.
Hiring your children is also a great way to start their retirement savings at an early age. Typically, contributions can be made to your child’s individual retirement account (IRA) based on that child’s earned income (i.e. wages). For 2013, the maximum contribution that can be made to an IRA for your children is $5,500, but the contribution cannot be greater than their earned income for the year.
You can contribute to either a Traditional IRA or a Roth IRA. However, contributing to a Roth IRA is most likely the more favorable choice in this scenario as the contributions are made post-tax (likely at 0-15%), and when amounts are withdrawn from the IRA, they will be done so tax-free. For example, if you pay your daughter $5,500 and she makes a $5,500 contribution to a Roth IRA, she will have paid no tax on those IRA contributions, as her standard deduction covers the wages, and when she withdrawals the contributions at retirement she will pay no tax on the distribution.
Employing your children in your business can be a quick and easy way to generate some additional tax savings, kick-off your children’s retirement savings, and provide your children with important career training that can be particularly crucial for future succession planning if you hope to run a multi-generational family business. However, as every taxpayer’s scenario is different, please consult with a tax professional to make sure that having your children work for you works for your tax situation.