COVID-19 has created unusual times for all of us and it has been especially trying for small businesses. With all the uncertainty, it has business owners concerned more than usual about their financial condition and their employee situation. One thing that may help during this crisis is hiring your children to work in the family business.
If you have a business and it is taxed as a sole proprietorship or a partnership that you and your spouse own together, then you could realize some real tax savings from hiring your child, especially if that child is under the age of 18. Following are some of the tax advantages.
First advantage is that you move that income from your tax bracket to their tax bracket. If they make under $12,400 which is the standard deduction for 2020, all of the earned income is offset by that deduction, so no federal income tax is owed. If they are 18 or under, they do not have to pay Social Security or Medicare taxes on that income, either. No federal income taxes, Social Security or Medicare taxes! WOW, that sounds pretty good, huh?
Secondly, as their employer, you are exempt from paying the employer portion of Social Security and Medicare taxes as well as Federal Unemployment Tax on their wages. You also get to take a business deduction for the wages you pay them, so you reduce your income taxes as well as your self-employment taxes. It will also reduce your adjusted gross income (AGI) which could save you from being subject to the different phase outs that are based on AGI such as education credits, IRA deductions, and medical expenses to mention a few.
If the family is financially stressed due to COVID, the income can help keep the family afloat. If it is not needed, then the child could begin to contribute to an IRA. This could be a deductible IRA or they could start building a ROTH IRA. The maximum IRA contribution for 2020 is $6,000 so if they started a deductible IRA, the child could make $18,400 before they would owe any federal income tax.
One caveat is that the child must be an actual employee. If you are audited by the IRS, you will need to provide time records documenting when the child worked and that you paid your child a reasonable salary for the duties performed. I have clients that have their children performing various duties such as handling their social media, answering phones, lawn mowing, pulling weeds, packing boxes, cleaning the office or stuffing envelopes. As long as it is a duty that you need to have performed in your business and it appropriate for the age of your child, you can pay your child a reasonable wage and get the business deduction.
You will also need to meet all the legal requirements such as giving your child a form W-2 at year end to show the wages paid and preparing payroll reports as required by an employer when they have employees.
Even if you are not a sole proprietor or family partnership, it could still be advantageous by moving income to the child’s lower tax bracket. With the potential of employees unable to work due to COVID concerns, it could be advantageous to have another employee available to fill in as needed. Your child may have more available hours to work with all the changes in school schedules related to the pandemic.
If you think this is a possible tax savings that you would like to take advantage of, please ask your CPA or tax advisor for help.
And…another added benefit is that you can teach your children the value of money, how to spend wisely, save well and develop a strong work ethic that will serve them well in their future work careers.
A little more about us:
Located in West Des Moines, Iowa with a branch office in Winterset, Iowa, McGowen Hurst Clark Smith (MHCS) celebrates 70 years of extending excellent service to our clients, providing them with accounting, auditing, consulting and financial planning expertise.
Established in 1946, our staff has grown from 3 to 60 employees, making us large enough to provide our clients with a broad base of experience and resources, yet small enough to offer very personalized service—which we feel makes us stand apart from other CPA firms. In addition to the traditional services of Accounting, Tax Preparation, Audit and Business Consulting, MHC&S offers our clients specialized services including Estate Planning, Business Valuations, Cost Segregation Studies, Retirement Planning, QuickBooks Training, Financial Advisory Services, Fraud Detection and Deterrence, Business Succession Planning, Litigation Support and more.
MHCS is a member of CPAmerica International, Inc., a national association of accounting firms offering membership to only 90 firms throughout the United States. This association offers a wide pool of additional technical expertise to the members firms, as well as continuing professional education necessary to maintain the degree of excellence which MHCS feels is vital in today’s business environment.