As a business owner, you can save family income and payroll taxes by putting your child to work for your business. Here’s how.
Shifting business earnings
You can turn some of your high-taxed income into tax-free or low-taxed income by shifting some business earnings to a child as wages for services performed. For the wages to be deductible as a business expense, the child’s work must be legitimate and the child’s salary must be reasonable.
Example
Suppose you’re a sole proprietor in the 37 percent tax bracket. You hire your 16-year-old son to help with office work full-time in the summer and part-time in the fall. He earns $10,000 during the year and doesn’t have other earnings.
You can save $3,700 — 37 percent of $10,000 — in income taxes at no tax cost to your son, who can use his $12,550 standard deduction for 2021 to shelter his earnings.
Family taxes are reduced even if your son’s earnings exceed his standard deduction. The unsheltered earnings will be taxed to him beginning at a 10 percent rate, rather than your higher rate.
Income tax withholding
Your business likely will have to withhold federal income taxes on your child’s wages. An employee usually can claim exempt status if he/she had no federal income tax liability for last year and expects to have none this year.
Exemption from withholding cannot be claimed if:
1. The employee’s income exceeds $1,100 for 2021 (and includes more than $350 of unearned income).
AND
2. The employee can be claimed as a dependent on someone else’s return.
Keep in mind that your child probably will get a refund for part or all of the withheld tax when filing a return for the year.
Social Security tax savings
If your business isn’t incorporated, you can save some Social Security tax by shifting some of your earnings to your child. Service performed by a child younger than 18 while employed by a parent isn’t considered employment for FICA tax purposes.
A similar but more liberal exemption applies for FUTA (unemployment) tax, which exempts earnings paid to a child younger than 21 who is employed by a parent. The FICA and FUTA exemptions also apply if a child is employed by a partnership consisting only of his/her parents.
Note: There’s no FICA or FUTA exemption for employing a child if your business is incorporated or is a partnership that includes non-parent partners. But there’s no extra cost to your business if you’re paying a child for work you’d pay someone else to do.
Retirement benefits
Your business may be able to provide your child with retirement savings, depending on your plan and how it defines qualifying employees. If you have a SEP plan, for example, a contribution can be made for the child up to 25 percent of his/her earnings, limited to $58,000 for 2021.
Contact TrueBlaze Advisors if you have questions about these rules in your situation. Some of the rules for employing children may change from year to year and could require your income-shifting strategies to change, too.