02/ 02/ 2007
by Rachel R. Mims, CPA, and Kim B. Smith, CPA
Save tax dollars in your business by hiring your children
If you have young people in your family who need to earn a few extra dollars, consider hiring them to help out around your business. It's a great way to teach kids real-life entrepreneurial skills--while benefiting your business' bottom line. Here are a few things to consider before you put Junior on the payroll:
Calculate the potential tax savings. Reducing the family's overall tax burden is the most important benefit to business owners who hire their children. By paying wages to your child, you can shift income from your higher tax bracket to your child's lower tax bracket. For example, suppose a business owner's marginal tax rate is 25 percent. If he pays his son $5,350 in wages, the owner will save $1,338 in federal taxes. In addition, the son will not owe any federal income tax on the $5,350, because of his standard deduction. Plus, the son can use this sheltered income to contribute up to $4,000 per year to a Roth IRA--a smart way for a child to begin a college savings plan or get a head start on saving for retirement.
Make sure wages are earned. One worry parents have when their children have income is the "kiddie tax." The kiddie tax imposes the parents' highest marginal tax rate on a child's unearned income over a certain threshold. But if the wages paid to your children are earned income, the money isn't subject to the kiddie tax.
Avoid payroll deductions. If the business is a sole proprietorship or a partnership in which only the parents are partners, any wages paid to a child are exempt from the federal unemployment, or FUTA, tax. In addition, any wages paid to a child under the age of 18 are exempt from the Federal Insurance Contributions Act, or FICA tax. These exemptions reduce the payroll taxes that must be paid by the business. However, be careful: This rule doesn't apply if your business is a C or S corporation.
Set a reasonable salary. There are a few pitfalls to be aware of before hiring your children, unless you want to pique the interest of the IRS. Make sure the child works reasonable hours and that his pay is comparable to what a non-family member would earn for the same job. In determining pay, consider the child's age and what type of meaningful work he can perform. One good way to set the salary: Consider what other workers who are your child's age earn for similar work. Also, beware of nepotism. Make sure that fringe benefits paid to your child are nondiscriminatory. In addition to damaging morale among your employees, the benefits may be counted as nondeductible expenses.
NFIB.com
Want to learn more about guiding your children to a life of small-business ownership? Check out articles from the NFIB Young Entrepreneur Foundation in the "Young Entrepreneur Facts" section of www.NFIB.com/toolsandtips
