There are many sound reasons for allowing your children to work in the family business. From the difficulty of the current job market for college graduates to helping our children to determine their career path, the family legacy of a business can offer lasting personal and professional success.
But there is another highly compelling reason, which are the tax benefits.
It is actually possible to turn some of your high-taxed income into tax-free or low-taxed income by employing your children. Of course, the work must be legitimate, and the amount paid must also be reasonable for the wages.
In other words, your children need to have a real job that is compatible with what the market would offer another candidate.
According to this Thomson Reuters Tax & Accounting News article, family taxes are cut even if the child’s earnings exceed his or her standard deduction. That’s because the unsheltered earnings will be taxed to the child beginning at a rate of 10 percent, instead of being taxed at the parent’s higher rate.
Kiddie taxes are applied to the child if he or she does not file a joint return for the tax year and (1) hasn’t reached age 18 before the close of the tax year or, (2) his or her earned income doesn’t exceed one-half of his support and the child is age 18 or is a full time student age 19-23.
When it comes to retirement planning, additional savings are possible if the child is paid more (or works part-time past the summer), and deposits the extra earnings into a traditional IRA. For 2015, the child can make a tax-deductible contribution of up to $5,500 to his or her own IRA.
Also, of special importance to students, additional intra-family tax savings in the form of education credits may be available. For 2015, taxpayers may claim an American opportunity tax credit (AOTC; formerly known as the Hope credit) equal to 100 percent of up to $2,000 of qualified higher-education tuition and related expenses plus 25 percent of the next $2,000 of expenses paid for education furnished to an eligible student in an academic period.
Lastly, there are FICA and FUTA exemptions. Employment for FICA tax purposes doesn’t include services performed by a child under the age of 18 while employed by a parent. This can generate some savings for a parent who runs an unincorporated business, including an entity disregarded as separate from its owner for tax purposes.
A similar but more liberal exemption applies for FUTA, which exempts earnings paid to a child under age 21 while employed by his or her parent.
With the right planning, you and your children can enjoy the benefits of working in the family business together. SC&H Group’s Tax Services team understands the unique business, economic, and regulatory environments that can impact your organization’s performance – and your tax burden. Contact the SC&H Group Tax Services team here for more insights into how you can take advantage of the tax benefits of hiring family members.