Often, our children come to us asking for a monetary donation to whatever they have going on at the moment, be it a toy from the toy store or a meal at Chick-Fil-A. Regardless, we know it’s going to cost us parents money. Well, this year I have a solution for you to help your child earn money and also earn you a valuable tax deduction.
If you own a sole proprietorship, a single member LLC, or an LLC/Partnership owned by both parents of the child in question, you can hire said child and write the wages off on your taxes. Sweet, right! If the child is under the age of 18, their wages won’t be subject to Social Security and Medicare taxes, which will save you both 15.3%. If the child is under age 21, you will save an additional 6% by not having to pay FUTA tax (Federal Unemployment Tax Act) as well.
The standard deduction in 2015 was $6,300 so that means you could pay your child with no tax consequences up to that amount. Anything over that amount and the child would be subject to federal income tax, but he/she might be in the lowest income tax bracket of 10%. And because your children will now have earned income, he/she can make a contribution to a ROTH IRA up to $5,500 they can later use for college or retirement tax-free. So the total cash benefit, receiving premium tax savings, funneling to your child, that you would have spent anyway is $11,800. Are you screaming due to excitement yet???
Now, there are rules you need to follow to hire your children, write their wages off on your taxes and avoid IRS disallowance of the write-off:
- Have a written job description – Make sure this description details the duties your child will perform. Make sure that it’s relating to your business and isn’t including any household chores such as making your bed or walking the dog.
- Pay a reasonable salary/wage – Do your research to make sure the amount you will pay your child is within reason for the role they will play in your business. If you already have existing employees performing the same task your child’s pay should be in alignment with theirs. If it’s a new role, do research to see what people are paying locally for those tasks. Also, make sure you are paying the correct minimum wage. Some states have raised their minimum wage to differ from the federal standard read more about that here.
- Complete the appropriate employment forms – Have your child complete form W-4 just like any other employee. I know this may be complicated for a 10-year-old so here is a line by line video tutorial. You can also just have the child write “EXEMPT” in box 7 if they are a student and eliminate/save the child from paying federal income tax altogether. Besides the W-4, they will also need to complete form I-9 (or you on their behalf if they are underage). As an employer, you will need to file for a Tax ID number if you don’t already have one you can do it online by clicking here.
- Keep a timesheet – Keep a written or digital log of the days and hours your child is working. Make sure their gross pay matches the number of hours worked multiplied by their hourly wage or the salary agreed upon matches the number of hours stated for work in the written job description.
- Pay in Cash – Ok, don’t pay in actual cash, but make sure you are paying your child via check or direct deposit being deposited into their own bank account. Don’t make the mistake of paying for swim lessons or a trip to the movies directly and get your deduction wiped away.
Hopefully, hiring your children not only benefits your bottom line but also helps them gain some financial freedom as they learn to manage their paycheck and spending. It can also minimize your worries about their financial future because you are investing into it. If you want a handy worksheet that not only tracks your payroll expenses but also helps to manage all of your business deductions, you can find it here.