As a business owner, you likely have two primary goals for your work: make as much money as possible and do anything possible to lower your tax bill. However, many small business owners miss one key deduction right in front of them: their children. Many business owners are unaware there is a tax strategy where they can pay their child, deduct those wages, and the child is still not subject to tax. But, before you start cutting your child a check, it is important to know the IRS rules and how your entity structure affects the deductibility of your child’s wages. Additionally, every business owner should consider factors unrelated to tax savings before hiring their children.
How to do this legally
Job Roles: To claim their child’s wages as a deduction, business owners need to ensure that their children are performing legitimate work for the business, which is age-appropriate. The job role does not need to be significant but still ordinary and necessary for your business. The IRS wording is vague, which provides a great opportunity for you to be creative and find a job opportunity engaging for your child, while providing a service for your business that you may have been missing. Some great examples are hiring your teenage daughter to run your social media accounts or hiring your 10-year-old to organize and clean the office. As long as you can make a reasonable case to the IRS that the job your child performs is needed, the wages are deductible.
Labor Rules: If your children are minors, certain rules apply to the type of labor and hours they can perform for your business.
All business owners need to ensure that they follow all youth labor laws determined by the U.S. Department of Labor.
The only exception to this rule is the minimum age requirement (usually 15 or 16, depending on the business’s state). You can still hire your children even if they are under the minimum age requirement, which is another excellent benefit to hiring your children.
Any expense that is ordinary or necessary to your business, is deductible against business income. This includes all wages paid to employees that are performing services for the business. However, sole proprietors, single member LLCs taxed as a disregarded entity, and partnership LLCs owned by a taxpayer and their spouse are not required to pay payroll taxes on wages for their children! This means that all the wages you pay to your child will go straight to their pocket, and thus, more money stays in the family.
On the flip-side, corporations still have to pay payroll taxes for all employees, regardless of relationship status with owners.
However, if it still financially makes sense, parents who are corporate shareholders should still consider hiring their children since it is a tax-deductible expense and a way to keep money in the family. The main difference is that your child’s pay will still have Social Security and Medicare tax taken out of their net pay.
How this affects your child’s taxes
IRS Publication 929 discusses all the IRS rules regarding children and dependents. Taxpayers who can be claimed as a dependent are limited to a deduction of the greater of $1,100 or their earned income plus $350 up to the standard deduction for their filing status. This means parents can pay their children up to the child’s standard deduction amount tax-free. For example, if your child is single, you can pay your child $12,550 dollars since that is the 2021 standard deduction amount for single taxpayers.
Your child’s taxable income will be $0, and they won’t owe the IRS come April 15th.
Other Factors to Consider
While hiring your child may sound like an overall win with what you’ve learned so far, there are still some potential negative backlashes that need to be considered.
- Child’s role with their earned money: Paying your child means they have more disposable income, and that may change the family dynamics of what expenses parents pay for versus what expenses are covered by the child. It would be wise to consider discussing the changing role of money in the household before hiring your child. Your kid may be thrown off if you expect them to use their earned wages for expenses that you previously paid on their behalf. Having these discussions before you hire your kids will help ensure no one is surprised with their new responsibilities.
- Child Employee’s Morale: While hiring your child may provide great benefit for you, a child who is not the biggest fan of work may not see it as a great opportunity. Your child may have a low work ethic that ultimately hurts your business overall. If the job they are hired for is not getting done, then parents may be left with the awful realization that they have to fire their child. Before hiring your child, you should look at other areas of their life, such as school, sports, or their social life, to consider their strengths and weaknesses to figure out if they would make a good employee in your line of work. No parent wants to be the one who has to deliver bad news to their child that could potentially affect their relationship for years to come.
- How other Employees React: Additionally if you are guilty of nepotism, other employees may not respond well to you hiring your child. If your kid will expect special treatment on the job and you give them special treatment, it can cause resentment among other employees, leading to problems with staff morale. Business owners need to be honest about their ability to treat their child as an equal employee before hiring their kid to work. Hiring your child for a tax benefit is not worth it if you end up losing your other employees that have been helping your business succeed for months or years.
Many business owners and their families can benefit greatly by hiring their children to work for the family business. If, after considering all factors, you believe hiring your child is the right decision for your family and your business, contact your payroll department to get started and reach out to a tax professional to determine your dollar amount of tax savings.
At Abacus CPAs, our focus is you! We believe that our employees and clients deserve to interact in an environment that fosters growth, trust, and confidence. Our team focuses on tax, accounting, audit, and business consulting to partner with you and your business. Abacus professionals provide leadership by relentlessly pursuing the best guidance possible so those we serve can make smarter decisions.
You can learn more about the topic in this blog by contacting us. We are here and happy to help! Call us today at 417-823-7171, find us on Facebook, LinkedIn, and Twitter, or visit our website www.abacuscpas.com to learn more.