Business owners are always looking for ways to save money, whether on expenses or taxes. In many family businesses, children can start to help from a young age. In addition to nonfinancial benefits, there are some great tax advantages for doing so. If your child is helping in your business, use the following tips to maximize your tax savings and ensure you stay compliant when implementing this tax strategy.
1: Income Limits
A person who earns income as an employee, even when they are a dependent of someone else, can claim a deduction up to the standard deduction limit ($12,950 for 2022). This means that the effective tax rate is essentially zero. Most business owners are in a higher tax bracket and thus would generate a tax benefit by paying their children up to the standard deduction limit. However, there could be benefits to paying more.
2: Labor Laws
Labor laws differ by state. It’s important to research or hire professional help to ensure you are not breaking any laws by hiring a child. In most states, there is an exclusion from the minimum work age requirement when children work for a parent. This is not a major concern for this tax strategy but it’s important to remain compliant.
3: Reasonable Compensation
You can’t pay your child thousands of dollars for a few hours of work. The work that your child performs must be documented and compensated reasonably. This means that if they are performing janitorial work, which is paid $20 per hour in your area, that is what you can compensate your child for. Also, don’t compensate your children as independent contractors since they will likely fail a test for independence and it will force them to file a return if their compensation is $400 or more.
4: Business Tax Structure
If your business is taxed as a C- or S-corporation, then you’ll pay FICA for your children, regardless of their age. This slightly diminishes the tax savings for S-corps since FICA will be an additional 15.3% tax on money that otherwise might have been distributions. However, unlike C- or S-corporations, if your business is structured as a sole proprietorship or partnership (or LLC taxed as either), you can pay your minor child (less than 18 years old) without having to pay FICA. Regardless of tax withholdings, even if they are all zero, you still need to generate a W2 for your children at the end of the year.
5: Proper Use of Wages
When you pay your children for work, the money is theirs. This means that those wages should be spent on the child and not go back to the parent. In most situations, this is not an issue since there are many expenses for children: clothes, school, food, etc. Another option is to take the funds, with the consent of the child since it’s their money, and contribute it to a 529 college savings plan.
If there are tasks in your business that your children can do, consider hiring them and taking advantage of the tax benefits. Keep in mind the tips above to ensure you stay compliant and maximize your tax benefits. While this strategy is simple to explain, the paperwork can be complex so make sure you consult with your tax advisor or payroll specialist.