Having children under 18 work on the family farm will save you in income taxes and in taxes on wages paid.
Employ your children on the farm to save on taxes
Here’s a win-win for you: Hire your children to work on the farm. You can save on taxes while helping your children financially prepare for the future.
By employing your children, you are taking money out of a parent’s tax bracket and putting it into a child’s lower or zero percent tax bracket, says Stephen Fiala of Fiala CPA in Mesa, Ariz. "This can provide significant tax savings."
The savings come in two forms, says Larry Kopsa, a partner with Kopsa Otte in York, Neb. The first savings are in income tax. Children under age 18 can earn up to $6,100 annually tax-free. The second savings is for the parents, who don’t have to pay Social Security and Medicare taxes on wages paid to children under the age of 18.
For example, if parents pay their child $6,100 and are in the 15% tax bracket, they will save $1,848 in federal income and payroll taxes, Fiala says.
Kopsa notes that if the farm is established as a corporation, it cannot be considered a parent, even if the parent owns 100% of the corporation. In this case, the corporation can still benefit from low income tax rates for the child, similar to parents hiring children older than 18, but the wages would be subject to Social Security and Medicare withholdings.
In order to deduct wages paid to a child as a business expense, the work must be legitimate and the salary reasonable. What makes a wage "reasonable" is open to interpretation, so Fiala suggests seeing what other, similar jobs are paying.
Additionally, the work and salary must be documented. "The more you pay a child, the more
documentation we need," Kopsa says. "If you are going to pay a kid $500, it’s not a big deal. If you pay the child $5,000 or $10,000, you need documentation." Also, be sure to match the responsibility to the age of the child.
Kopsa suggests using a calendar or time sheet to record hours and wages. In this same document, you can include when you pay your child, which should be done in a businesslike manner. "There is a tendency to wait until the end of the year and then cut a big check to the child. Those year-end payments could be scrutinized."
Saving for the future. By employing your children, you can teach them valuable lessons about spending and saving, Fiala says. He suggests having your children place some of their earnings in a retirement account, such as a Roth IRA. "That money will grow tax-free throughout their life, and then can be taken out tax-free."
Kopsa agrees. He says that children can make a great amount of money by contributing the maximum amount to a retirement account, just putting it in there and letting it cook.
Checklist for Hiring Your Children
To make sure the employment arrangement between you and your child is suitable with the Internal Revenue Service, Larry Kopsa, a partner with Kopsa Otte, provides these guidelines:
- Document the hours worked and payment rate for your child. This can be a simple time sheet or calendar. Just know that the more you pay your child, the more documentation is needed.
- Have a separate checking or savings account for your child, so the money goes into a separate account.
- Issue a W-2 tax form to your child at the end of the year, as this is an official employment situation.
- Pay your child throughout the year. While a lump payment on Dec. 31 is legal, it can look suspicious.
- February 2013