Pay Your Children for Business Chores

Pay Your Children for Business Chores I am astonished by how many business owners overlook the simple tax strategy of hiring their children. The benefits of the hiring vary by the type of tax return that you file, as you will see below. Did your under-age-18 children help you in your business this year? Did you pay them for their work? You should. Why? First, wages paid by the parent to the parent's under-age-18 child for work done in the parent's business are both1 deductible by the parent, and exempt from payroll taxes. Thus, if you operate your business as a proprietorship, you face no payroll taxes on the W-2 wages you pay your under-age-18 child. Second, your child can use the 2011 standard deduction to eliminate taxes on up to $5,800 in wages. Third, your child can contribute up to $5,000 to a tax-deductible IRA and exclude that amount from taxable wages. Example. Your child is age 14, and she has no earned income other than what she earns from you. You pay her $10,800 in fair market wages for work she actually does during the year. You deduct the $10,800 and pocket $4,320 because of your 40 percent tax bracket. Your daughter collects the $10,800 and pays zero federal income taxes because The IRA deduction removes $5,000 from taxable income, and The standard deduction removes $5,800 from taxable income. Your family unit has $4,320 in additional spendable cash. Key point. To avoid payroll taxes, the wages paid by the parent to the child must be on a W-2. If you use a 1099, you destroy payroll tax benefits because your recipient child will pay self-employment taxes on the 1099 income. Corporation or LLC. If a corporation does the hiring, both your corporation and your child face payroll taxes. The same is true with an LLC because the law treats the LLC as a corporation for payroll taxes. Paying payroll taxes is not a deal breaker for the strategy, but it does reduce the net family benefit. It is also a negative when considering the corporation or the multi-owner LLC as a possible choice of business entity. Ask me for an article titled "Big Tax Breaks for Hiring Your Child" written by Murray Bradford, CPA " for additional insights into this strategy. Planning note. The kiddie tax does not apply to the child's wages. The kiddie tax applies to unearned income, such as dividends, interest, rents, etc. ********************************* The real point is that good tax planning produces cash and builds net worth. In the example above, the family unit gained $4,320 in after-tax cash from hiring the child. If the child works for the parent for 10 years, the family unit gains $43,200 in after-cash, a nice addition to the investment or college-fund portfolio.