Tax Benefits of Hiring your Children
Business owners would be able to reap the benefits of substantial tax savings by hiring their children as employees to work for their businesses. Owners would be able to benefit by shifting their business income from their higher tax bracket to their children’s lower tax bracket, this technique would be more beneficial to business owners with substantial business income. Owners would also be able to fully deduct the salaries their children earn as a legitimate business expense, thus lowering their gross income and ultimately taxes owed.
Further, if your business is a sole proprietorship or partnership, with both partners being the parents and your child is under 18, you would not have to withhold or pay FICA taxes on their earnings. Also, if your child is under 21, you would also avoid federal unemployment taxes and in some cases state unemployment taxes. These exemptions do not apply to other forms of business entities, such as an incorporated business or a partnership with non-parent partners. Children, however, are required to pay income taxes on their earnings if their gross income is the larger of $1,000 or their earned income plus $350.
However, this is worth mentioning, the IRS has been on the lookout for parents who claim their children as employees because they are well aware of the many tax savings. Any red flags that are raised would cause them to heavily scrutinize and in some cases audit your business. If the IRS concludes, that your children really aren’t employees, you would lose all tax benefits and have to pay back taxes owed, and in some cases penalties.
There are certain precautions that you can take to avoid that scenario.
First of all, parents must pay real wages for services actually performed. These services must be ordinary and necessary for your business and the child’s compensation must be reasonable. Household chores and personal errands would not count as ordinary. Also payments in the form of food and clothing would not suffice as wages. The IRS believes that parents have a legal right to support their children, so those creative forms of payments would be disallowed. A highly recommended form of payment would be by checks because parents would have proof of payments made, when and how often they occurred. Parents should pay their children once or twice a month, using timesheets to keep track of hours worked. In essence, it would be best to treat your children as though you would an actual employee. With that said, complying with all legal work requirements would signify your child’s legitimacy. Parents should fill out IRS forms W4, I-9 and file a W-2, for each child at year end, to prove how much you paid your children.