Hal Zemel, CPA, J.D., LL.M.
07.16.19 | Berdon Industry Insights
Business owners who hire children or grandchildren can obtain a host of tax breaks and other nontax benefits. These advantages apply if your manufacturing, distribution, or retail business operates as a sole proprietorship, is a single-member LLC treated as a sole proprietorship for tax purposes, is a husband-wife partnership, or is an LLC treated as a husband-wife partnership.
There are a number of benefits that result from making your children/grandchildren an employee of your business. For example, working children/grandchildren can gain valuable on-the-job experience, save for their college or other expenses, and obtain useful insights on how to manage money. Additional advantages for the children/grandchildren and business owners include:
- Shifting the business owner’s high-taxed income into tax-free or low-taxed income;
- Realizing payroll tax savings (depending on the child’s age and how the business is organized); and
- Enabling retirement plan contributions for the child/grandchild.
Tax Exemptions and Savings
If your child/grandchild is under age 18 and is hired as a legitimate full-time or part-time employee, the wages will be exempt from Social Security tax, Medicare tax, and federal unemployment (FUTA) tax. Moreover, the FUTA tax exemption lasts until the child/grandchild is age 21. Be aware that there is no Social Security or Medicare tax exemption when employing a child if your business is incorporated or is a partnership that includes nonparent partners. Additionally, you should check your state and local taxing authorities to see if workers compensation and disability insurance coverage is required.
When you hire your child/grandchild, you get a business tax deduction for employee wage expenses. In turn, the deduction reduces your federal income tax bill, your self-employment tax bill (if applicable), and your state income tax bill (if applicable). However, in order for your business to deduct the wages as a business expense, the work performed by the child/grandchild must be legitimate and the salary must be reasonable.
A business owner operates as a sole proprietor and is in the 37% tax bracket. He hires his 16-year-old son to help with office work on a full-time basis during the summer and part-time in the fall. The son earns $10,000 during 2019 and does not have any other earnings.
The business owner saves $3,700 (37% of $10,000) in income taxes at no tax cost to his son, who can use his 2019 $12,200 standard deduction to completely shelter his earnings.
The family’s taxes are cut even if the son’s earnings exceed his standard deduction. The reason is, the unsheltered earnings will be taxed to the son beginning at a rate of 10%, instead of being taxed at the parent’s higher rate.
Getting a Jump on Saving for Retirement
Your business may also be able to provide your child/grandchild with retirement benefits, depending on the type of plan you have and how it defines qualifying employees. Since your child has earnings from his or her job, he/she can contribute to a traditional IRA or Roth IRA.
Aside from having an annual income limitation, the only requirement for your child/grandchild to make annual Roth IRA contributions is having earned income for the year that, at minimum, equals what is contributed for that year. If the child/grandchild earns some cash from a job, he/she is entitled to make a Roth IRA contribution for that year.
For the 2018 tax year, a child/grandchild who works can contribute the lesser of: (1) his or her earned income or (2) $5,500. While the same $5,500 contribution limit applies equally to Roth IRAs and traditional deductible IRAs, the Roth IRA option is usually better for children/grandchildren because making modest contributions (i.e. $1,000 annually) over time to their Roth IRA can really build up by retirement age.
The only way that hiring your child/grandchild can be a tax-smart idea for your business is if the job offered is a real job. As such, it is essential for business owners to keep the same records as they would for their other employees in order to substantiate the hours worked and duties performed. Such records should include timesheets, job descriptions and, most important, the issuing of a Form W-2.
If you have any questions about how these rules apply to your situation, don’t hesitate to contact Hal Zemel at 212.331.7684 | firstname.lastname@example.org, or your Berdon advisor.
Berdon LLP New York Accountants