As the owner of a family business, you may gain more than just personal satisfaction from hiring your children. Hiring your child to work for you can, in some circumstances, can lead to significant tax savings. This article will briefly describe some of the tax advantages that may be available if a child works in the family business.
The most obvious tax advantage from hiring your child is gained from income shifting. Suppose you own a business, and you are in the 33% federal income tax bracket. You hire your daughter to work for you over the next year, and she earns $6,100 in 2013. Assuming that she did legitimate work, and that her wages were reasonable, she may entirely offset the income she earned through use of her standard deduction (assuming that she didn’t have another job or other sources of income). In contrast, you would pay $2,013 in federal income tax on the same income.
Making an IRA Contribution
Depending on how much the child earns, an IRA contribution may lead to additional tax savings. In 2013, up to $5,500 of an individual’s contributions to an IRA are deductible. So, in the above example, if your daughter made $11,600 and contributed $5,500 to a traditional IRA, she would still have no federal income tax liability. If the family business sponsors a retirement plan, such as a 401(k), even greater retirement contributions may be realized.
Taking Advantage of Education Credits
Your child may also be able to use educational tax credits for additional savings. The two main educational tax credits are the American Opportunity Tax Credit and the Lifetime Learning Credit. Both credits are phased out at fairly low levels. As a result, they are usually unavailable to higher-income taxpayers.
If you, as a parent, pay higher education expenses for your child, only you can take the credits. But, for parents with higher incomes, the phase-out may make them ineligible for the credit. In that case, it may be worthwhile not to claim the child as a dependent. Doing so allows the child to take the credit, which may offset extra income.
If you decide to hire your child, be sure that you comply with any withholding requirements. In most cases, family employers still have to withhold taxes on their child’s wages. However, for the reasons stated above, your child will probably get a substantial refund when his or her tax return is filed. You may be able to avoid some withholding if your child is a minor and your business is unincorporated.