Are you Aware That Employing your Child will Reduce your Family Tax Burden?

Generally, taxpayers who own a business are quite conscious about their taxes. Well, for those it is important to know that employing family members who are in a lower tax bracket than the business owners (Usually children or grandchildren) can shift taxable income to them, thus reducing the family’s tax burden.

IRS is well aware of this technique of shifting income to child and is likely to examine any family employment arrangement to make sure the compensation allotted is reasonable.

If it is unreasonable relative to the services performed, it may be recast as income to the business owner.

Advantages of hiring children in the family business:

• If business owner deducts reasonable compensation paid to the child and the child receives and reports earned income from compensation which would be often taxed at a lower rate than the business income.
• Wages and compensation paid by a sole proprietorship (or partnership, if the parents of the child are the only partners) child who is under age of 18 are exempt from FICA payroll taxes.
• Compensation is exempt from FUTA tax if the child of the proprietor (or partner) is under age of 21.
• Earned income paid to the child enables the child to fund an IRA contribution.
• Child employee may be eligible to participate in employer-sponsored fringe benefits such as health and disability insurance or employer-provided vehicles for business travel.
• Child will qualify to make a deductible contribution to a traditional IRA since he is either not covered by an employer retirement plan or his income is beneath a certain level.

EXAMPLE:

Nick hires her 14 years old son George to work in her restaurant, which operates as a sole proprietorship. The restaurant employees earn $10 per hour; George is paid $6 per hour based on the types of services he is able to perform. In 2015, George earned $1700 in wages from the restaurant. His other income is $425 of dividends.

George avoids paying federal income tax on the entire $1700 of wages since he is entitled to a standard (lesser of $6300 or $300 plus his earned income, if it exceeds $1050) and Nick business is entitled to a $1700 deduction for the wages paid to George. In addition, only $125 ($425 – $300) of George’s unearned income is taxed and it is taxed at 0% dividend tax rate. Hence, in either ways it is beneficial to reduce business and family tax burden.