Be Tax-Smart and Hire Your Children
Hiring your children to do legitimate work for your business has often been a great tax-saving strategy. With the new changes in the tax laws (Tax Cuts and Jobs Act) this tactic is even more attractive for 2018. Before you run off and hand the office keys to little Charlie, please consider reading the entire article first.
If you do decide to hire your children as employees (they must perform legitimate work) in your business, you may deduct their wages from your business income as a business expense. Additionally, if they’re under 18, you won’t have to withhold or pay any FICA Tax (Social Security or Medicare)*. By doing so, you can shift a portion of your business income from you and your wife’s tax bracket to a much lower bracket.
* You don’t have to pay payroll taxes for employing your kids if your business is a sole-proprietorship, a single-member LLC taxed as a disregarded entity, or an LLC taxed as a partnership and owned solely by you and your spouse. But if your business is a corporation, there are workarounds for that as well.
Why is this more attractive with the new Tax Laws (TCJA Reform)
Your kids will have to pay tax on wages earned from your business, but only if they earn more than the standard deduction amount for the year. The Tax Cuts and Jobs Act increased the standard deduction from $6,350 to $12,000 for taxpayers who file as Single! Meaning, your kids can earn up to $12,000 in one year, and they will not owe a single dime in tax!
In case you are feeling generous and would like to bonus them, he or she will be taxed at a much-reduced rate. You can refer to the IRS site for the complete Income Tax Rate, but here is a portion of that:
- $9,526 to $38,700 (12%)
- $38,701 to $82,500 (22%)
- $82,501 to $157,500 (24%)
Assume your child earns $19,500 in 2018:
- He or she will have to only pay $750 in income tax
- ($19,500 – $12,000 (Standard Deduction) x 10% = $750
Sounds too easy? It is, but here are some rules you need follow:
- Hiring your child to do real work
You must hire them and make sure your child is a real employee. This means your child should do actual work for your business that is ordinary and necessary under IRC Code Section 162. Your child doesn’t have to be indispensable. But, the tasks your child performs should be common and helpful for your business.
For example, you might hire your tech-savvy child to help with your business’s website and social media accounts. Your child is performing common and helpful tasks for your business, even if the tasks aren’t directly related to your products or services.
It is highly recommended that you keep track of the work and hours your children perform by having them fill out timesheets. Doesn’t have to be anything fancy, a simple log will do, but do keep track! Remember, you can’t hire your kids for personal services, such as washing your car, mowing your grass, and other chores around the house. Wages paid must be for real work for your business.
- You must comply with employment laws
You must treat your children just like any other employee. You must comply with the same legal requirements when you hire them; you need to complete a W-4, complete the citizenship (I-9) forms, and other employment verification. For hiring, employees and other related questions refer to our good partners at ADP.
- You must pay them real wages and the compensation must be reasonable
You must give your children actual paychecks. You cannot pay them in IOU’s, count their future college tuitions as income, or deduct their birthday parties as “wages.” IRS wants you to feed, educate, and support your children regardless if you are employing them or not.
We highly recommend paying your children by company checks or direct deposit, not with cash. Try to follow the same pay-cycle as other employees. The funds should be deposited into their account or a custodial account that you control until they turn 21. It is very important to have a “paper trail” in case the IRS comes knocking; you will be able to produce records easily.
When hiring your children, you must keep their compensation reasonable. You cannot over-pay them simply because they are related. For example, you hire your child to answer calls for you. You pay them $45 per hour, but the average rate for someone with similar skills is $20. The IRS may deem the extra $25 per hour as unreasonable. You can call local employment agencies in your area and find out what the going rate is for someone with similar skill sets.
If the IRS concludes that your children aren’t really employees, you’ll lose your tax deductions for their salary and benefits. And they’ll have to pay tax on their benefits. To avoid this, you should follow these simple rules.
** This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
For more information, please contact Shawn Daei at Allied Tax Advisory Group and Schedule an appointment. We are conveniently located in Encino and the Westside.
Call Us @ (818) 338-9090