As a small business owner, hiring your children to work for your business may save you money when filing taxes. It might sound too good to be true, but if you handle the situation properly and file the right paperwork, you may be able to write off nearly half of their wages on your business’s taxes.
Imagine that you have a home-based photography business. You employ other photographers to assist you during some of your photo shoots, and you typically pay these assistants as contract workers using Form 1099-MISC.
Things are going well, and your business has grown to the point that you need more help at home, so you enlist the assistance of your children to help you process orders. This is a win-win—you get some much-needed help and your children develop a good work ethic and earn some spending money on the side.
However, you can’t just give your child a sham job to get the tax benefit. As the business owner, you must make sure that your child’s wages are reasonable and that he or she is being paid for real work that you must document. You must also keep records on the wages you pay your child.
If you pay your child to help you, and you choose to deduct his or her pay as a business expense, you must follow proper procedures, which may include paying your child as a W-2 employee. Your child may also need to complete a federal tax withholding form, such as a W-4 and fill it out as “exempt” so that no federal tax will be taken out. The same strategy may apply if your state has an income tax—your child may need to fill out “exempt” on the state form as well.
Now here’s where the savings can come in. According to the IRS, if you hire your own children under the age of 18, the paycheck you give your child is not subject to Social Security. If the child is under the age of 21, the paycheck is also not subject to the Federal Unemployment Tax Act. The benefit of this arrangement is that your business may save about 10 percent by not having to pay those taxes.
At the end of the year, if your child’s income is less than the standard deduction (currently about $6,000), he or she has no requirement to file a return and won’t have to pay any federal income taxes on that money. Meanwhile, your business may be able to deduct the payments made to your child and reap the savings there as well.
Caveats when hiring your children
Be aware that these savings only are available for businesses that file a Schedule C—typically sole proprietorships or partnerships. If your business is organized as a corporation and you elect to be treated as an S Corporation or C Corporation by the IRS, you will not receive the same tax benefits if you hire your children to work in your business.
Also, always remember to adhere to any child labor laws. The Fair Labor Standards Act sets 14 as the minimum age for employment, but laws vary by state. Check with your state to find out its minimum age requirements.
Dealing with payroll issues
You might want to consider hiring a professional to assist you with payroll filings to avoid inadvertently missing a deadline or incorrectly filling out the quarterly paperwork with the IRS or state. You could wind up spending a significant amount of your precious time fixing your payroll error, and you might even end up paying penalties on top of it.
If you already have someone who helps you with bookkeeping or taxes, inquire about payroll services and setting up your children on your payroll.
You could also interview your local bank and several local accounting firms to get a feel for their payroll processing fees. Check references and online reviews to see if businesses similar to yours are pleased with the payroll provider’s performance.
If you have additional questions about hiring your kids to work for your small business, consider contacting a Certified Public Accountant (CPA) who can help answer your tax questions.
Bill Nemeth and Merry Brodie are both Enrolled Agents and the founding partners and owners of Tax Audit Guardian, an Atlanta-based group of professionals who specialize in assisting troubled taxpayers. The married couple also recently sold their 24 Jackson Hewitt Tax Service franchises. Additionally, Brodie works with small businesses as owner of Brodie Accounting Services and Nemeth is active in education and membership arms of the Georgia Association of Enrolled Agents.