|Rich Best has spent 28 years in the financial services industry, as an advisor, a managing partner, directors of training and marketing, and now as a consultant to the industry. Rich has written extensively on a broad range of personal finance topics and is published on several top financial sites. Recent books include The American Family Survival Bible and Annuity Facts Revealed: What You MUST Know Before You Invest.|
Why Hiring Your Kids This Summer Is a Win-Win-Win
Business owners with children can not only get some extra help during the summer months, but they can also benefit from an excellent tax-saving strategy. Putting your children to work in your business is also a great way to teach them some work ethic and form the foundation of sound money management principles. It’s a win-win-win situation, of which too few business owners take advantage. There are, however, some strict guidelines that must be followed to ensure you have no problems with the IRS.
Make Sure It’s Legitimate
As a business owner, you can hire whomever you want, but if you are going to hire your kids, you need to make sure the work they perform is legitimately business-related. In other words, if you simply have them perform family chores, or use their time to do their homework, you could run afoul of the IRS, who would want to see proper documentation of the work performed along with justification for wages paid. It’s important to keep in mind that paying your children for services they perform for your business creates a legitimate, tax-deductible business expense, so get the most out of them if you can.
Avoid Withholding Payroll Taxes
If your children are under 18, and you operate as a sole proprietor or limited liability company (LLC), you are not required to withhold payroll taxes such as FICA, or the state and federal unemployment payments (FUTA and SUTA). Also, in most states, you don’t have to pay for Workers Compensation coverage because your children are covered under your family health insurance. If you operate as an S- or C-Corporation, you are required to withhold payroll taxes unless you pay your children from a family management company, which is set up as a sole proprietorship.
If your children are over the age of 18, you could hire them as subcontractors, which will avoid the withholding of payroll taxes. Instead of issuing them a W-2, you would issue a 1099-MISC form to report their wages.
Your Children Can Avoid Paying Taxes
All taxpayers receive a standard deduction when filing their taxes. The standard deduction, which for 2020 is $12,400, allows any wage earner to receive $12,400 in income without being taxed. If you keep your kids’ total earned income under that amount, they keep it all. Also, you can still claim your kids as dependents and take the exemptions. You can even take the Child Tax Credit if you qualify.
Set Your Kids up with a Roth IRA
Because your kids will have earned income, they are eligible to establish their own Roth IRA. The significant advantage of a Roth IRA is that the funds can be used to pay for college expenses without paying a penalty of taxes on the withdrawal. At the very least, you can teach your kids the magic of compounding interest and show them how their money will grow over time. Young kids can get excited by the prospect of becoming a millionaire by systematically saving a few hundred dollars a month.
The Bottom Line
With this strategy, you can lower your business income, pay your children to help cover their college expenses, and set them on a course for financial responsibility. There is no real downside to the strategy as long as everything is legitimate, and your kids are good workers. It would be important to run everything by your accountant, who can ensure everything is appropriately structured.
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