Perhaps like you, I am a small-business owner. As a business owner or professional, we are always looking for ways to become more efficient at what we do and how our businesses operate. While there are many ways to do that, one of the more obvious yet complex ways to do so is through tax planning strategies. When it comes to taxes and your business, you're likely to find yourself headed down the rabbit hole of information which ultimately takes time away from you doing what you do best; Running your business! Without listing every possible business tax deduction, credit, IRS revenue ruling, etc., here is one consideration that can potentially save you thousands! Literally.
Hire Your Children
Whether you're a seasoned and successful business owner, or just getting off the ground with your new endeavors, hiring your children may be a great idea. Please know I do understand that there are many more considerations to make other than taxes when considering hiring your children. In fact, I believe taxes should be one of the last reasons to hire them. If involving family members with the day-to-day operations of the business will decrease productivity or potentially cause other long-term issues, DON'T DO IT. I do planning for many successful family business owners, however I have also seen a lot of dysfunctional family businesses.
Here's what the IRS says:
"Payments for the services of a child under age 18 who works for his or her parent in a trade or business are not subject to social security and Medicare taxes if the trade or business is a sole proprietorship or a partnership in which each partner is a parent of the child. Refer to the "Covered services of a child" section. Payments for the services of a child under age 21 who works for his or her parent in a trade or business are not subject to Federal Unemployment Tax Act (FUTA) tax. Payment for the services of a child are subject to income tax withholding, regardless of age." 1
What does this mean?
If you are a sole-proprietor, partnership, or even an LLC taxed as a partnership, and the only owners/partners are you and or your spouse, then the children's wages would not be subject to Social Security and Medicare taxes (FICA). FICA is a payroll tax comprised of Social Security at 6.2% and Medicare which is 1.45%. Therefore 7.65% is withheld from the employee's paycheck, and on top of that you the employer pay another 7.65% for that employee as well (which ends up being tax deductible to the business); All together it is 15.3%.
Therefore, if you meet the previously mentioned requirements and your child (or children) is on payroll, their wages are not subject to the FICA payroll tax. They don't pay their tax and you don't pay the other half. This allows them to take home more and maybe even all of their pay, tax-free. Tax-free? How? The new standard deduction after the Tax Cuts and Jobs Act of 2017 was $12,000 ($12,200 for 2019). This means that if you pay the child $12,200 or less, they won't owe any taxes because the standard deduction wipes it out completely. If you pay them more than $12,200, they still won't owe any FICA taxes but will always be subject to federal and potentially state income tax. Wait there's more! You will still be able to deduct their pay on your taxes as wages!
Do you have multiple children you can employ? Say three... That could be $36,600 that is paid into your household, that no taxes are due on! You can have the children use that money for their own food, activities, hobbies, savings, etc. This can also be a great way to teach them about money and how to manage it. This is of course opposed to you paying yourself that $36,600 of income, paying all payroll taxes taxes on it, likely more income tax on it, then spending it on your children for all of the same purposes.
How To Hire Your Children
Let's face it, your twelve year-old daughter is not going to become your new Controller or Foreman. I would love for my nine-year-old daughter to work as another licensed advisor for me, but that's not going to happen. One realistic strategy that is often put into practice would be to hire your younger children (preferably under 18), to do some of the maintenance or errands for the business. This would only require maybe a couple days a week after school. Not only will this introduce them to the concept of "work," but it can also help teach them valuable life lessons, especially when you are there to coach them! If you are a professional you may even use this as an opportunity to introduce your child to your profession and start the early stages of a succession plan for your business.
Here are some creative examples:
Running Business Social Media Accounts
Organizing or Cleaning Offices
Washing Company Cars
Buying Supplies or Running Errands
Take Incoming Phone Calls
The bottom line is that the job needs to make sense, and it needs to be reasonable. This is not a "tax loophole", everything needs to be legitimate. There should even be an actual job title and description. Always consult with your tax professional on whether or not a particular job for your child is a good idea.
What If I Have a Corporation or S-Corporation?
Generally speaking a child cannot take advantage of avoiding FICA and FUTA payroll taxes if you operate a corporation. However there is technically a way you can still accomplish this, it just requires a few more steps. This workaround involves creating a "Family Management Company" owned by you and/or your spouse as a sole-proprietor or LLC (taxed as partnership) for example. The role of this company is to document and record all work performed by the children. It needs to have a purpose such as scheduling and monitoring the work they perform as well as keeping track of hours or wages paid. It serves as a support role to your primary corporation.
The "Family Management Company" would essentially hire the children and charge the corporation a fee for services. That fee would then be paid to the children on payroll by the sole-prop or LLC (taxed as partnership). This would allow the income paid to potentially avoid FICA and FUTA payroll taxes. Before acting on a strategy like this, speak with your CPA and/or attorney as some may have more specific ways of going about the strategy.
The Bottom Line
If it makes sense, you should strongly consider adding your child or children to the company payroll. As you can see there are numerous potential advantages based on your family's situation. If you are a business owner or professional without a succession plan, this may be a way to teach your child the ropes in the hopes that one day they may be able to take it over for you; Plus, you can reap the potential tax benefits now!
If you are a corporation, is it really worth it to jump through hoops to take advantage of this strategy? It depends on your situation! Look at the tax benefits. If you consider the time, money, and effort it takes to account for the additional payroll taxes, the extra few steps could pay off significantly in the long run. If all of this seems overwhelming, have your financial planner and CPA get in touch with each other to help execute a plan for you. If your planner doesn't do this type of planning, contact me to learn more.
Cameron Valadez is a CFP® Practitioner.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, and CFP® in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.
Waddell & Reed and its representatives do not provide tax advice. This is meant for educational purposes only. It should not be considered specific legal, tax or other professional advice, nor does it constitute a recommendation to take a particular course of action. Please consult with a tax advisor and other financial professionals regarding your personal situation prior to making any financial related decisions. 08/19