By: Jason Crowley, CPA, MBA
As a business owner, there are many tax strategies you can utilize to minimize your tax liability. One of these strategies is hiring your children to work for you. It can give you an amazing opportunity to teach your children the value of work and the responsibility of managing personal finances—extremely valuable life skills not taught in most school systems. However, there is also another benefit for parents who employ their children. As long as the work is legitimate and your child is under the age of 18, their wages can be deducted against net income from your business while avoiding payroll tax expenses.
New Limit for 2018
The previous tax law stipulated that children who are employed by their parent could earn up to $6,300 tax-free using this strategy. However, the new Tax Cuts and Jobs Act of 2017 now increases this amount to $12,000 per year tax-free!
Priority Entity Type
This tax provision specifically applies to small family businesses, such as sole proprietors or closely held family partnerships jointly owned by the children’s parents.
S Corps and Other Entity Types
All other entity types aside from the two mentioned above are not able to get this tax treatment. However, there is a workaround by taking a hybrid approach. For this, look at paying your children out of a family management company. You can create a family management company run as a sole proprietor, separate from your S Corp or other entity type. The family management company then charges the corporation a fee for your child’s services, which removes them from the corporate payroll. And yes, this is completely within the rules! Note that record keeping and documentation for this type of structure is critical to show you are not abusing this strategy. Make sure you keep thorough records and documentation up-to-date.
When you employ your children, create legitimate work for them that is age and ability appropriate. Remember, the IRS could inquire about this strategy, and your defense is greatly dependent on how well you have kept proper documentation. Keep it real, and make compensation reasonable.
By employing your children, you can reduce your own taxable income while providing your children with tax-free income. Your children can learn to manage their own expenses, save for college, or even put this income into a ROTH IRA.
Every individual and business has unique characteristics that require intimate knowledge to make the proper decision on these types of strategies. Please seek advice from your tax advisor before implementing any complex tax strategies to avoid potential pitfalls. If you wish to discuss how I may be able to help you achieve your future financial goals, please contact me at (435) 632-9156 or at firstname.lastname@example.org.
About the Author:
Jason Crowley, CPA, MBA, and founder of Belikos Specialty CPA Services, has lived in southern Utah for over 20 years. He is originally from the Bay Area in Northern California, where most of his family still resides. He is a proud graduate of Dixie State University, where he completed his undergraduate studies, and Southern Utah University, where he completed his MBA. He is a true lover of the outdoors and enjoys being physically active. During the summer, you will find him trying to spend every possible moment of his leisure time at the lake with his family. When it is not lake season, he also enjoys making memories with his family by traveling to exotic destinations and hiking the southern Utah landscape. His family consists of his beautiful wife, Lauren, and their two awesome children, Dax (8) and Capri (4).