Owning your own small business tends to come with a lot of responsibilities, but there can also be some great compensations. One nice feature is that you’re the boss, so you can provide your children with real-life work experience by hiring them. Moreover, by giving them that job, you may qualify for additional tax breaks.
There are very clear rules. Your hired children can’t be paid in “pizza” – this has to be real money at a realistic market rate for performing real work.
Here are some of the factors to consider:
Many small businesses qualify, but not all
Certain tax breaks are available when the children are under 18 years old and are employed by a parent in a sole-proprietorship business, a spousal partnership, or a single-member-limited-liability company.1 The exemptions do not apply for S corporations, partnerships that include nonparent partners, or corporations.2
What can you deduct from your taxes?
You get a business write-off for the children’s wages on Schedule C, E, or F depending on the nature of your business. By lowering your adjusted gross income level, this may reduce your own income taxes, too.3 Social Security, Medicare, or federal unemployment taxes are not owed on the child’s income, a benefit worth $15.30 of every $100 paid to them.4 Note that there may be annual limits that vary, and state taxes may be payable, too. Check carefully with your accountant.
Establishing an IRA for your child
Consider establishing a Roth IRA (an IRA is an Individual Retirement Account) for your child. Roth IRA’s are funded with money you have already paid income taxes on. The advantage? At the other end, in retirement, that money can be withdrawn tax-free. As your children right now may not be taxable at all, meaning they don’t pay income taxes, this would be a perfect time to set them up with a Roth IRA account and deposit some of their money into it each year. This investment has tremendous long-term growth potential as it rolls over.
Retirement for your children may seem an awfully long time away. However, there’s an excellent chance you’ll be paving the way for them to enjoy a comfortable life, knowing the future is secure.5
More deductions for education
If your business has a written Educational Assistance plan, you may be able to deduct up to $5250 from the business, provided that the money is put into education.6 Your child can exclude this amount from their taxable income, too. Note that there are anti-discrimination laws associated with such plans, so make sure other employees are offered the same benefit. No more than 5% of the total benefits paid under this plan can benefit the business owners, their spouses, or their dependents.7
What to be careful about?
To take the tax deduction, you can’t pay the child $30 an hour for work that would normally cost $15. All work your children perform should be recorded by timesheets. Your business should pay them by check, deposited by the child into a bank account (or retirement account). You will need to submit a w-2 form for the child to the IRS as you would for any other employee.8
Remember the “kiddie” tax
To discourage parents from shifting “unearned income”-- meaning interest and dividend payments – over to their children (who are subject to low or no income tax rates) the government enacted a “Kiddie” tax. Consult with a tax professional.
Having your kids on the payroll brings benefits beyond just knowing what they’re getting up to. You’re providing your children with part-time work that might otherwise be hard to find, and the money is staying within your family. Your business gets the deduction for the wages paid out, and this may lower your personal income, possibly putting you into a lower tax bracket. In addition, there are tax advantages for the children on their income, which can be put towards education or retirement plans. Perhaps most important of all, you’ll be providing them with working skills that could make them more hirable in the future, while showing them the monetary benefits of self-reliance – a lesson worth more than all the tax breaks in the world.
Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation. 2015-15226 Exp. 12/17
1, 2, 4 Laura Saunders, “Tax Dos and Don’ts for Hiring your Child,” The Wall Street Journal, July 18, 2014
3. Bill Bischoff, “Hire your kid, get a tax break,” Marketwatch.com, April 17, 2013
5. William Baldwin, “Make Your Kid Rich with a Roth IRA,” Forbes, April 18, 2011
6,7 Troy Onink, “Entrepreneurs: Deduct $5250 Per Year of your Kid’s College Tuition Expenses,” Forbes.com, February 21, 2013
This material is intended for general public use. By providing this material, Guardian is not undertaking to provide investment advice for any specific individual or situation, or to otherwise act in a fiduciary capacity. Please contact a financial professional for guidance and information specific to your individual situation.