If you own a business, hiring your children may be one one of the smartest business decisions you can make this year.
If you are a self-employed or have a partnership with you and your spouse as the only partners, you can save on payroll taxes if your children are under 18 and you hire them to do work in your business you would have to pay others to do anyway.
In such unincorporated businesses, your minor children are exempt from federal FICA and FUTA taxes. Usually, they are also exempt from state unemployment and disability taxes.
There is no limit on how much your children can earn, but any wages have to be reasonable and legitimate pay for work performed. This requires careful planning and documentation. More about this later.
Your children’s wages may also be taxed at a lower income tax rate than you would pay on your own personal federal and state tax returns.
The lowest federal tax rate for individuals is currently 10%. Your dependent children can make up to $5,150 in earned income during 2007 without owing any federal income tax. If these children earn enough to file a federal return, they can earn up to $7,825 in taxable wages and pay only 10% federal taxes.
All wages you pay to others, including your children, are deductible from your gross business income, reducing your own tax liability. This can be a real tax advantage for parents subject to self-employment taxes.
Good record keeping is essential. First, you should have a written description of work your child is expected to perform. Also, fill out a W-4 form for each child and keep it on file.
Have your child keep a time card of all hours worked.
Write regular paychecks, as you would for any employee, rather than paying in cash, like an allowance, or settling up once or twice a year.
Make sure the hourly rate is reasonable for the work performed. You can certainly pay above the federal or state minimum wage rate, but $50.00 an hour for cleaning your home office or performing clerical tasks probably won’t survive an audit. A good rule of thumb is to pay what it would cost to have similar work performed by an employee other than a family member.
At the end of the year, provide each child with a W-2, and file the proper paperwork with the government (w-2 copies and W-3).
Here is an example of how a self-employed person with two children under 18 could benefit from this plan.
Let’s say a taxpayer has net income from self-employment of $75,000 in 2007 and does not hire his two children in the business. If this is the family’s only income on a joint return with the standard deduction and 4 exemptions, the total federal tax liability, including income tax and self-employment tax, would be $16,776.
If the taxpayer hired both the children and paid them $5,000 each, neither child would owe federal tax. The taxpayer’s self-employed net income would be reduced by $10,000 to $65,000. The total federal tax liability would be $13,968. The difference is $2,808, almost 17% in tax savings. If state or local taxes are included, the savings will be even greater.
Under certain circumstances, parents in a 2 person partnership could realize similar savings in this scenario.
An additional benefit to hiring your own children is that it can be a very useful tool in teaching financial responsibility at a young age. They can use their own money to pay for many of the things they need or want that you would otherwise have to pay for yourself with no tax benefit. It’s a great way to teach them to budget.
A real job also gives your children actual experience in the world of work. No allowance, even when tied to chores, can be quite as effective a teaching tool.