With summer here, you can save family income and payroll taxes by hiring family members, reminds Larry Kopsa of accounting firm Kopsa Otte in York, Neb. “You may be able to turn high-taxed income into tax-free or low-taxed income, achieve Social Security tax savings and even make retirement plan contributions for your child.”
In order to deduct wages paid to a child as a business expense, the work must be legitimate and the salary must be reasonable.
Each child has a $5,700 standard deduction—income tax isn’t owed on less than that amount.
Kopsa gives this example: Suppose you are in the 35% tax bracket and you hire your high-school aged daughter for recordkeeping full-time in the summer and part-time in the fall, paying her $5,700. You save 35% of $5,700 or $1,995. If you pay a child more than their standard deduction, they can reduce the tax they pay by making tax-deductible contributions to their own retirement account. Should the child go ahead and pay taxes on amounts over $5,700, it will be taxed at a rate beginning at 10%.
You most likely do have to withhold income taxes on wages paid to your children; they’ll later get them back as a refund if they qualify.
If your business is not incorporated, you can also save some self-employment (Social Security or FICA) taxes because they are not due on services performed by a child under 18 while employed by a parent.
Suppose you are a sole proprietor and you draw $120,000 from the business. As in the previous example, you pay your child $5,700 in wages. Your self-employment income would be reduced by $5,700 and you would save $165.30 in FICA taxes.
Ask your accountant about the FUTA exemption that applies to a child under age 21 while employed by his or her parents or partnership.