Hiring a junior family member can result in significant tax savings for your business. Putting your children on the payroll will allow you to shift potentially highly taxed income to a lower tax rate. It can even be tax-free in some situations. This tax strategy works because dependent children are entitled to a deduction against earned income of up to $5,350. Therefore, a parent in the 35% tax bracket can shift $5,350 of income to a child saving over $1,872.50 of income taxes.

Parents of unincorporated businesses may also save on Social Security taxes. This is because employment for FICA tax purposes does not include services performed by a child under the age of 18 while employed by a parent. In addition, depending on the type of retirement plan you have, you may be able to fund retirement benefits for your child that are deductible from your business income.

It is important to understand, however, that the work performed by the child must be legitimate. The amount you pay your child must also be reasonable. In other words, paying your 17-year-old daughter $200 per hour to sweep the office is not a good idea.

To help avoid problems, keep accurate records of hours worked and the services performed by your child. Assuming you can justify the job and the pay rate, there is excellent potential for tax savings.

To illustrate, assume a parent can employ a child and pay them $9,350 of wages. The first $5,350 is tax-free. The additional $4,000 could be used to fund a tax deductible IRA for the child. Using this strategy for a parent in the 35% tax bracket saves $3,272.50 in income taxes, puts away $4,000 of retirement benefit and provides $5,350 of tax free income to be used for education funding.

Please do not hesitate to call our offices if you have any questions or would like to explore this opportunity.

- By Jamey R. Bryan, CPA (Principal, Mentor office)

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