Children can be very expensive! We want to talk about a few ways your children can save you some money. If you own a small business, it’s time to put those kids to work to cut down on some taxes. In 2018, you could potentially save up to $4,600 per child simply by using this strategy.
First, a few ground rules:
1. The job arrangement has to be REAL. Your kids have to ACTUALLY work and you have to ACTUALLY pay them. Your kid needs to be setup like any other employee. You need to have a W-4 and I-9 on file. Your child should also fill out timesheets to document their efforts and hours.
2. They need to perform an ordinary and necessary business function for you. For instance, managing social media, cleaning the office, distributing flyers, etc are all approved activities. Doing their homework or other after school activities do not count.
3. Their pay needs to be reasonable for the level of work they are providing. A 12 year-old dumping garbage cans should not be making $50/hour.
4. Speaking of reasonableness, how young is too young? Cases with kids as young as 7 have been upheld, so long as their job requirements are commensurate with their abilities. You will have a hard time getting the IRS to believe that your 6 month-old is managing your social media accounts. So stick with only hiring your kids at about age 7 and giving them reasonable responsibilities.
Now let’s go over some of the benefits:
1. There are three types of taxes we are looking to minimize; Federal Income Taxes, State Income Taxes, and FICA (Social Security and Medicare) taxes.
a. Federal Income Taxes – In 2018 your child may earn up to $12,000 without paying any federal income tax.
b. State Income Taxes – In NC in 2018, your child may earn up to $10,000 without paying any income tax.
c. FICA – Depending on your entity structure, your child may or may not be exempt from FICA taxes.
2. All combined, if your federal tax rate is 25%, and you pay your 2 kids $10,000 each, you could save up to $9,200! Your savings will vary based on your tax rate and your entity structure and how many kids you can pay.
Strategies to maximize the benefits even further:
1. Your kids can use their new income however they’d like. They may pay for some of their afterschool activities, or save up for a summer camp, or but the latest iDevice. Some parents even elect to have their kids pay part of their own cell phone bill or other monthly costs. Since these are costs that would have otherwise come out of your pocket (and at your tax rate!), this saves you a good chunk of money.
3. If you are helping your kids save for the future, they can dump their net earnings into a ROTH IRA. This account pays out tax-free at your kids’ retirement age essentially giving them income that has NEVER been taxed. ROTH IRAs have additional benefits where some of the funds may be accessed early without penalty if needed. They are not as rigid as traditional IRAs.
4. You can put the money into a 529 plan to save for your kids’ college education. This money also comes out tax-free meaning that you can pay for school with never-taxed dollars.
How to get started:
1. Because there are a few hoops to get through, you want to first calculate what your potential savings will be. You will need the help of a competent tax professional. If the savings would be minimal, then you can stop here without doing any further work.
2. If the savings are significant, you will need to start your employee paperwork, assign duties, set them up in your payroll system, etc.
3. Once payroll is running and your kid is working, you need to decide how/if you are going to maximize the benefits you are receiving from this strategy. Setting up a ROTH IRA or a 529 Education Savings Plan can help you get more from this strategy.
How we can help
We have significant experience and expertise in this field and can help you figure out a plan that makes sense for you as well as help you in setting up all the necessary files, accounts, paper-trails, etc. Because of our unique fixed fee pricing model, you will know our total cost before we begin any work, giving you piece of mind that there won’t be any surprises down the road.
If your business is an S Corp, some of the effectiveness of this approach can be lost. There are other approaches we can discuss to help you take advantage of some of these same benefits including using royalties or a management company.
Please contact us to schedule time with one of our professionals for a free consultation to help you decide if this strategy might work for you.