Tax Benefits from Hiring Children to Work in the Family Business

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June 5, 2015
Robert Jackson, Joe Demko
SmithAmundsen Tax Legal Update

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Junior is sitting on the couch and you want to put him to work? We can tell you how to do that AND save money!

AdultUnemployment figures have improved, but it can still be difficult in the current job market for college students and recent graduates to find jobs. The family business may be the ONLY place for some young people to find work or to find their first job.

EMPLOYING YOUR CHILD MAY GENERATE TAX SAVINGS!

Income shifting: Regardless of how a business is organized, its owners may be able to turn some of their high-taxed income into tax-free or low-taxed income by employing their children. However, the work done by the children must be legitimate, and the amount that the enterprise pays them must be reasonable for the wages to be deductible.

For example, a business person in the 33% tax bracket for 2015 hires her 17-year-old son to help with office work full-time during the summer and part-time into the fall. He earns $6,300 during the year (and doesn't have earnings from other sources). If that $6,300 otherwise would be paid to the parent, she saves $2,079 (33% of $6,300) in income taxes at no tax cost to her son, who can use his $6,300 standard deduction for 2015 to completely shelter his earnings.

Family taxes are cut even if the child's earnings exceed his or her standard deduction because the unsheltered earnings will be taxed to the child beginning at a rate of 10%, instead of being taxed at the parent's higher rate.

Kiddie tax implications: The kiddie tax applies 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. (Code Sec. 1(g)(2)) Thus, employing a child age 18 or a full-time student age 19-23 could cause his or her earned income to exceed more than half of his or her support. This, in turn, could help to avoid the kiddie tax on the child's unearned income (there is no earned income escape hatch from the kiddie tax for children under age 18). Even if the kiddie tax applies, it only causes a child's investment income in excess of $2,100 (for 2015) to be taxed at the parent's marginal rate. It has no impact, however, on the child's wages and other earned income, which can be sheltered by the child's standard deduction.

Retirement plan savings: Additional savings are possible if the child is paid more (or works Signpart-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. The business also may be able to provide the child with retirement plan benefits, depending on the type of plan it uses and its terms, the child's age, and the number of hours worked.

Overall, between the child's standard deduction and IRA contribution, a child can earn up to $11,800 in 2015 without paying any income taxes.

Learn more about this topic from an original article by RIA checkpoint.