Child labor is a subject that has a negative connotation in our society. For most people, it means depriving children of their childhood. It means forcing them to work when they should be at home watching TV, or playing in the fields.
But it is a different matter altogether if the child is employed by his or her parent’s company.
If you have a small business and you have children aged below 18 years old, it is highly recommended that you hire them as employees. It can be a very fulfilling experience to them. It can hasten their growth, develop a sense of pride and self-worth, and teach them to be more responsible.
Moreover, it can save your company thousands of dollars in taxes. It’s like hitting two birds with one stone—your children can be productive during their spare time and you and your company can get to save a lot of money.
Hiring teens and young adults in a family-owned business benefits both parents and the young ones. Parents get to save more as their businesses have a lesser tax burden. Children, on the other hand, can be productive and get some extra money for their extracurricular and summertime activities.
There are several ways for your company to benefit from hiring your children as workers:
- The child’s salary is free from taxes.
You might know that the first $6,300 of income in a fiscal year is free from federal taxes. This is called the Standard Deduction. So if you hire a child as an employee of your firm, you’re basically keeping that amount in the family. Hire someone else and that $6,300 is taken out of you.
That money coming from your own pocket can be used by your son or daughter to buy a car, or go on a vacation. Even better, he can use it to support himself or his college education.
- The child’s salary will be tax-deductible.
Let’s say that you are hiring your child with annual pay of $6,300. You can declare that amount as tax-deductible from your business income. The first $6,300 earned by a child working in his/her parent’s firm is not subject to tax. Yes, this means that your child’s earning will not only be subject to federal income tax but also state tax, FICA, or Medicare.
You, as the business owner, meanwhile, can declare that amount as fully deductible. This means that you will get a tax relief based on your child’s salary as an employee of your business.
For instance, your business is in the 35 percent tax bracket. You hire your 14-year old son to work in your office and help you with the filing of documents or working with the spreadsheets. For the year, he earns $6,300 in wages. He must also have no other sources of income.
You, as the business owner, stand to save $2,205 since the full amount of his wages will be deductible as compensation.
- No FICA taxes.
As mentioned earlier, your child’s salary isn’t subject to FICA tax. This means your firm won’t have to pay FICA taxes on your child’s wages.
However, there are certain requirements for your child’s salary to be exempt from this kind of tax:
- Your business is a sole proprietorship
- It is a husband-wife partnership
- It is a husband-wife LLC considered as a husband-wife partnership for tax purposes
- It is a single-member LLC treated as a sole proprietorship for tax purposes
It should be noted that your child’s salary is not exempt from FICA taxes if your business is a corporation. FICA tax exemption is also not applied if the business is a partnership, or one or more partners are not parents of the child.
- Setting up a retirement savings plan.
What most people don’t realize is that children under 18 can contribute to their own individual retirement account (IRA). This can be a great way for them to get a head start as far as saving and investing money is concerned.
Your child can contribute up to $5,500 to a traditional IRA. He can subtract the amount from their income for tax purposes. However, your child can’t make more contributions to what he earned in a year. So if he earned $5,000 in a year, the maximum IRA contribution he can make is $5,000.
- Shifting a parent’s higher-taxed income to a child.
Since your child can save by a) having his income exempt from taxes and b) having the option to set up IRA on the income, you can then shift your higher-taxed income to him.
Going back to our examples, your son makes $6,300 and then adds $5500 as a contribution to an IRA. Thus he has $11,800 shielded from taxes, and your business can write off that amount as a legit business expense that can reduce your gross income.
That’s the maximum amount that your child can make in a year sans tax. If you give him a higher pay than $6,300 in a year, the next $9,275 will only be taxed at a rate of 10%.
Thus, your son stands to have a tax of just $927.50 for the year on aggregate earnings of $21,075.
You’ll be wise enough to include that amount in your own income as you can incur a tax liability of $10,600. You can save up to $9,672 in taxes by doing so.
There are several things that you should know if you are to hire your kids as employees. Knowing these guidelines should keep the IRS from disallowing your company from claiming said tax exemptions:
- He/she must be a real employee.
Your children should be hired as bona fide employees. This means that they have work that is helpful and appropriate for your business. Typical jobs for children include routine office work such as typing jobs, stuffing envelopes, cleaning the office, answering phones, or making deliveries. Tech-savvy teenagers can help in marketing a company through social media. Or they can help in maintaining the spreadsheets of the firm.
They can’t be hired for jobs that have no connection with your business, like mowing your lawn at home. Suffice to say, children shouldn’t be asked to do household chores and get compensated for it.
Since your child is considered as a real employee, he or she should fill out their timesheets. It is also recommended that they sign a written employment agreement that specifies the duties and work hours of the employee.
- The work must be age-appropriate.
The work assigned to your child should be age-appropriate. There’s a chance that a 8 or 9 -year old child can help in some tasks in the office like stuffing envelopes or even making deliveries. But it will be difficult for the IRS to believe that a child aged below that age can perform any useful work for your firm. Employing a 6 or 7 year old for photocopying work or filing can put you in trouble with the IRS.
It’s also a no-no for children aged 16 years and below to work in a dangerous industry. Hence if your business is heavy equipment contracting, you can’t assign your 15-year old son to the field.
- The child should comply with legal requirements.
Since the child is considered a real employee, he or she should comply with the same legal requirements as you would when you hire a stranger. Thus, he will have to apply for a Social Security Number and fill out IRS Form W-4. He or she should also complete Form I-9 of the U.S. Citizenship and Immigration Services.
- Compensation must be reasonable.
Simply put, your child’s salary should be consistent with market rates.
Many shrewd business owners would try to give their children a big compensation because it can give them more tax savings in the long run. It would enable them to shift much of their income to their kids who are likely to be in a much lower income tax bracket. But you shouldn’t attempt to do this as the IRS would eventually find out about this if they do an audit.
In paying your children, you should give them reasonable compensation. The total compensation must include the salary plus all the fringe benefits such as health insurance and medical expense reimbursements.
To get an idea on how much you are to pay your child, you can call an employment agency to see the typical compensation for the type of work that your youngster will do in your business.
- Pay in cash.
It’s up to you to decide how much you would pay your son for the services he renders to your business. Just make sure that you pay him in cash if you don’t want to get in trouble with the IRS. Compensation in the form of foods and other things won’t cut it.
There was this case of a tax preparer in Washington who also owned an employment agency. She employed her three children aged 8, 11, and 15. The kids earned a combined $15,000 in two fiscal years for doing tasks like filing and stuffing envelopes. Their mom deducted their salary as business expenses. The IRS disallowed it.
Why? It’s because the children’s wages were used by their mom to pay for their food, often pizza. Also, she used the money to pay for their tutor’s fees.
While the mother argued that it was her children who asked her to spend their earnings that way, the Tax Court ruled in favor of the IRS. It noted that it is her parental obligation to provide food and support her children’s education, and the wages of the kids should not be used for these purposes.
- Be diligent about documentation and bookkeeping.
One way to ensure that this arrangement won’t backfire on you is to be diligent about the documentation and bookkeeping. Doing so would convince federal or state auditor that you reasonably employed your children for your business and that your tax claims are legit.
Aside from getting all the state permits necessary to employ children, your company’s recordkeeping and payroll tax accounting must also be fool-proof. The payroll for your kids must be done in the same way that an employer would do the payroll for another employee. Paying a fair market rate, as mentioned earlier, would also satisfy the auditors.
- Your child should also help your business.
Finally, business owners should not only be concerned with the tax savings they’ll get when they hire their children. They must also be sure that their children can do the tasks assigned to them. The children should be able to help the business, and not just for the tax savings that the firm gets because of them.
Sure, they’ll reduce taxes by employing a child. But if the child doesn’t do a good job at work, then it would probably best to hire another individual to do the job for the firm.
Let’s say that a father hires his 15-year old son to help typing documents in his office. He’s able to save $3,000 in taxes for doing so. But if his son just lounges around the office and doing nothing, then the father didn’t really get the best out of this arrangement. It would have been better for him to hire another person who can actually help his company.
With the tax savings that small business owners can get, it really makes a lot of sense for them to hire their children during summer or even on weekends. The business owner not only stands to save on taxes but also instills in his/her children values like hard work and responsibility.
If you decide to do this, you should ensure that you do things right. Get your children the necessary permits. Do your accounting cleanly. And give them real wages—not slices of pizza. If you do things correctly, you can save thousands of dollars in taxes while training your children who could be your successor one day.