The Financial Impact of Hiring Your (Non-Adult) Kids– December 12, 2013

Many of our clients are business owners who hope to some day pass on their business to one or more of their children. So, naturally, they bring their kids into the fold early on to learn the ropes, often exposing them first to simple tasks, such as stocking shelves or assisting with data entry, until ultimately the kids are grown and have become part of the company’s natural evolution. But regardless of your ultimate succession plan, there are certain tax-related and other financial considerations to be aware of when hiring your kids as employees.

  1. As a business owner, when you pay wages to your children you effectively lessen your own tax burden. By paying your children, who generally are subject to lower tax rates, your family’s overall tax liability is reduced. Additionally, if you are a sole proprietorship, or a partnership consisting of only you and your spouse, children are exempt from FUTA tax (if under age 21) and FICA tax (if under age 18), so the business withholds less payroll tax and retains more cash for the company’s use. Sole proprietorships and partnerships of a husband and wife also benefit from less self-employment tax liability, since more money is going to the kids.

    Since your dependants will now have earned income, they can take a much higher standard deduction than the typical $1,000 limitation. In 2013 they can take up to a $6,100 deduction and the next $8,925 of wages after that will be taxed at only 10%.
  2. As a wage-earning employee, your child can start saving for retirement or to later help defray college costs via his or her own IRA. You can choose a traditional (tax deferred) or Roth (tax-free) IRA depending on your child’s age and goals.

So how much pay is “reasonable” for a child? Minimum wage should be the standard for younger children, e.g., 12- to 13-years old; while older children could potentially earn more. Be mindful that when it comes time for college, too much earned income may negatively affect your children’s ability to receive financial aid. Regardless of age, ensure the wages you pay your children are comparable to what non-family employees would receive for the same job, are appropriate for their age and skill level, and comply with all fair labor laws. It’s also a best practice to maintain regular records of your children’s work hours and adhere to an employer-employee relationship by having them fill out Form W-4 and provide them with a W-2 at year end.

It’s important to note that over paying your children for the services rendered (or not rendered) to the business in order to reduce the family’s tax burden can result in significant tax-related penalties. Therefore, it is critical that a fair wage is established and proper documentation of services performed, hours worked, etc. is maintained. Prior to implementing this tax-savings strategy you should thoroughly discuss such planning with your tax advisor.

For more information, contact a member of your service team.

This communication is for information only, and any action should only be taken after a detailed review of the specific situation and appropriate consultation.

Notwithstanding that these materials do not constitute legal, accounting or other professional advice, as may be required by United States Treasury Regulations and IRS Circular 230, you should be advised that these materials are not intended or written to be used, and cannot be used by you or any other person, for the purpose of avoiding penalties that may be imposed under federal tax laws. No written statement contained in these materials may be used by any person to support the promotion or marketing of or to recommend any federal tax transaction(s) or matter(s) addressed in these materials, and any taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor with respect to any such federal tax transaction matter.