This has to be one of the most under utilized tax strategies by small business owners with families today. Many don’t realize that paying their children under age 18 is an excellent strategy to minimize their tax liability, not to mention it creates a host of other ancillary benefits.
The days of the farm are continuing to disappear all across America and more and more children are leaving the home without work ethic, money management skills and a concept of entrepreneurship. Moreover, many small business owners forget that some of their most affordable labor is right there in the house with them eating at the dinner table. Get them involved in the business!!
The beauty of the tax benefit is two fold, and something that can’t be over emphasized. Run the numbers and you’ll be amazed.
First, when you pay your children under 18, you don’t have to withhold any income taxes or payroll taxes. (IRC Code Sec. 3121(b)(3)(A), IRC Reg Section 31.3401(a)(4)-1(b), and IRS Pub No. 15, (2011), p.10) This also applies to Workers Compensation (unless you are in the State of Washington- make sure you look up the rules for even your own kids at the WA Dept of Labor here).
Yes, that’s right no federal payroll tax withholding on your own kids and the general rule and reasoning regarding Workers Comp in almost all the states is that the government and insurance carriers don’t assume your children will sue you if they are hurt on the job- at least we hope not. They are also probably on your health insurance plan and you’ll pay the bill one way or another.
Second, all of us in the U.S. and including our children, don’t pay taxes on the first $12,000 of income this year in 2018! (See TCJA and increase in the Standard Deduction. Rev Proc 2011-52, Sec. 3.11(1), 2011-45 IRB). Also, the “Kiddie Tax” (if you have ever heard of that) doesn’t apply to ‘earned income’.
You can still claim your children on your tax return as a dependent and even tax the child tax credit, however, they don’t pay taxes on their earned income on the first $12,000!
Now the strategy. Where do the kids get earned income? You take a tax deduction in your business for paying your kids a legitimate wage or legitimate work and services. Thus, you generate an excellent tax deductible expense for your income taxes (inside your business) by pushing income to your children.
Now of course, I’m not advocating you pay your children as a ‘sham’ operation. That have to be legitimately involved in the business and you want to keep records of their time worked, as well as pay them a reasonable wage. Hiring your children to simply to ‘family chores’ is not going to qualify as a valid deduction and will certainly set you up for an audit. (See U.S. v. Renfrow, 104 AFTR 2d 2009-5497, 1/26/2009).
Here is the procedure, and it’s important you follow the write procedure or it could backfire on you!
The IRS allows any sole proprietorship or partnership (LLC) that is wholly owned by a child’s parents to pay wages to children under age 18 without having to withhold the payroll taxes.
However, if you have an S or a C-Corporation you do not receive this benefit of avoiding FICA when paying your children. Don’t pay your children out of a corporation, or you have to withhold payroll taxes. (IRS Pub No. 15, (2011), p.10).
Thus, we recommend you pay children out of a family management company (sole prop) paid a management fee from the Corporation, or simply pay them out of a Sole-Proprietorship or LLC with independent income and operations.
If you are paying children over age 18 or grandchildren, you have the option of treating them as a sub-contractor or employee, but you will have to withhold FICA and other typical payroll fees if they are an employee.
I have seen this strategy not only save clients thousands of dollars in taxes, but literally change the lives of their families. Children begin to learn work ethic and it can draw a family together in ways never fathomed by small business owners. Talk to your CPA and get a plan for this year before it’s to late.
* To sign up for Mark’s weekly Free E-Newsletter and receive his Free E-Book “The Top 10 Best Tax Saving Secrets Everyone Should Know” visit www.markjkohler.com.
Mark J. Kohler is a CPA, Attorney, co-host of the Radio Show “Refresh Your Wealth” and author of the new book “The Business Owner’s Guide to Financial Freedom- What Wall Street isn’t Telling You” and, “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP.