If you own a business, hiring your child or grandchild could be a great way to teach them valuable work skills and save thousands on taxes.
Let me tell you why.
1. Tax Benefits
One of the benefits of hiring your child is the tax savings. If you hire your child to work for your business, you can deduct their salary as a business expense to lower your taxable income. In addition, your child may not have to pay any federal income tax on their wage income if they earn less than the standard deduction. In 2023, the standard deduction for a single tax filer will be $13,750. It means your child can make up to $13,750 without owing any federal income tax.
By hiring your child, you may lower your tax bracket if you are in a higher tax bracket. For instance, if you belong to a tax bracket of 32%, but your child falls under a tax rate of 10%, paying them $23,750 can enable you to shift $20,000 of your income and consequently reduce your tax liability to $2,200 =$10,000*(32%-10%)
If your child is under 18, you will not have to pay payroll taxes on their wages. This rule only applies to sole proprietorships, partnerships, and single-member LLCs. For example, paying your child $13,800 in 2023 will save $1,056 in payroll taxes ($13,800 x 7.65%).
2. IRAs contributions
If your child has earned income from working for your business, they can contribute up to $6,500 or their earned income, whichever is less, to an IRA.
There are two types of IRAs suitable for children: traditional and Roth. The difference lies in when you pay taxes on the money you contribute.
The money grows tax-free in both types of IRAs. With a traditional IRA, you pay taxes when you withdraw the money during retirement. On the other hand, with a Roth IRA, when the child draws the money decades later, they won't have to pay income tax on it.
However, if the child earns less than the IRS's set amount, they will likely be in a 0% income tax bracket and won't benefit from the up-front tax deduction associated with traditional IRAs.
3. Working Condition Fringe Benefits
A working condition fringe benefit is a nontaxable benefit provided to employees to enable them to do their job or perform their duties more effectively. Working condition fringe benefits include company-provided cell phones or laptops, tools and equipment, work-related training, education, and even reimbursement of job-related travel expenses. The IRS considers these types of benefits necessary for an employee to perform their job duties, and therefore, they are not taxable to the employee.
As a business owner, you can provide these benefits to your child as an employee and claim a deduction for them on your tax return.
Example:
If you own an HVAC business and hire your daughter as a bookkeeper, you can pay her tuition for accounting colleges because the education is reasonable and necessary for her to do her job better.
4. Cautions
While hiring your child can be a great way to save on taxes and provide them with valuable work experience, it's important to take certain precautions to ensure that you follow all applicable laws and regulations. Here are some cautions to keep in mind when hiring your child:
1. Ensure that your child is actually an employee: Your child must perform legitimate job duties for your business. Their compensation must be reasonable and in line with what you would pay an unrelated individual for the same services. If your child is not performing real work or is being paid significantly more than they would be if they were an unrelated employee, you could run afoul of the IRS and potentially face penalties.
2. Keep accurate records: You should keep detailed records of your child's hours worked, job duties, and compensation, as well as any working condition benefits provided to them. These records help demonstrate that your child is a legitimate employee and that their compensation is reasonable.
3. Follow all labor laws: Your child must be paid at least the minimum wage and must be paid overtime if they work more than 40 hours in a week. Additionally, you must comply with all child labor laws, which restrict the types of jobs and hours minors can work.
4. Consult with a tax professional: While hiring your child can result in significant tax savings, some rules and regulations governing the employment of family members. A qualified tax professional can ensure you follow all applicable laws and maximize your tax savings.
Ready to streamline your tax management effortlessly? Connect with our experienced team at Arnold CPA, serving Texas.
Deer Park - CPA
Pasadena, TX CPA
