In the world of small businesses, keeping costs down and maximizing profits is a constant battle. One strategy some family-owned businesses consider is hiring their children. But is it just a way to give your kids an allowance, or are there real financial advantages? The answer is yes, there can be significant tax benefits to hiring your child in the right circumstances. Let’s explore how this works and what you need to consider.
Shifting Income and Reducing Taxes
Traditionally, you support your children financially. But by hiring them as legitimate employees and paying them a reasonable salary, you can shift income from your own tax bracket (which might be higher) to your child’s (which could be lower). This reduces your overall tax burden.
Here’s the key: the work your child does must be genuine and have a fair market value. You can’t simply create a make-work job to qualify for tax benefits.
Understanding the Kiddie Tax
There’s a concept called the “kiddie tax” that applies to unearned income (like investments) of children under 19 or students under 24 who are claimed as dependents. This tax can be higher than the child’s regular income tax rate. However, earned income (wages from a job) is taxed differently.
Here’s the good news: As of 2023, a child with no other income could potentially earn up to $13,850 (the standard deduction) and pay no income tax! Even if they earn more, the first $11,000 is taxed at a low 10% rate.
Example: Imagine you’re a self-employed business owner in the 22% tax bracket. You hire your child (with no other income) and pay them $16,500 annually. This reduces your income by $16,500, saving you $3,630 in taxes. Your child would have a taxable income of just $2,650 (after the standard deduction) and owe only $265 in taxes. In this scenario, the family saves a net of $3,365!
Reduced FICA and Self-Employment Taxes
There’s another tax advantage: FICA (Social Security and Medicare) taxes. When your child is under 18 and employed by you, they are exempt from paying their share of FICA taxes. This also means your business doesn’t have to pay its portion either. This further reduces your overall tax burden.
Similarly, by paying your child and lowering your business’s net income, you also reduce your self-employment tax liability.
Retirement Savings Opportunities
The benefits extend beyond immediate tax savings. If your child earns more, they can contribute those extra earnings to a traditional IRA (Individual Retirement Account). This allows them to save for retirement while also reducing their taxable income.
Bonus Tip: Consider a Roth IRA instead. While there’s no upfront tax deduction, contributions grow tax-free and can be withdrawn tax-free in retirement. This could be a wise choice for your child, who has many years until retirement.
Important Considerations
Before hiring your child, here are some crucial points to remember:
- Legitimate Work: The work your child performs must be genuine and have a fair market value. Don’t create fake jobs just for tax benefits.
- Age Restrictions: FICA and FUTA (unemployment tax) exemptions only apply to children under 18 or 21, respectively.
- Business Structure: These benefits primarily apply to unincorporated businesses or partnerships solely consisting of parents.
- Consult a Tax Professional: Tax laws can be complex. It’s always best to consult with a qualified tax advisor to ensure you’re following all regulations and maximizing your benefits.
Hiring your child can be a win-win situation. They gain valuable work experience and potentially start saving for retirement early. You, as the business owner, can benefit from significant tax savings. Remember, always prioritize genuine work and consult a tax professional for personalized advice.
