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ON THE MONEY: Putting your children to work

June 3, 2018 GMT

If you are a small business owner and have children, one of the best ways to save income taxes for 2018 is to put your kids on your payroll. The tax advantages can be quite meaningful, and the greater your income, the larger is the tax savings. Remember though, your employed children must actually work and provide meaningful services to your company, and you should keep accurate payroll records for them. Naturally, the amount of the income your children receive must be reasonable, just in case you are ever audited by the IRS.

The first tax benefit of this strategy is that you may pay your children up to $12,000 each in 2018 without them incurring any federal income tax liability at all. If the child is under age 17, you may still qualify for the child tax credit if you provide more than half of their support and meet the other requirements; i.e., the child is a U.S. citizen; has a Social Security card; and lived with you for at least six months of the year.

Beginning in 2018, the standard deduction for a child is $350 plus the child’s total earned income, up to a maximum of $12,000. This is a huge benefit when compared to earlier years, since all of this income will be received income tax free.

Bear in mind that “kiddie taxes” are not in play here, since the income your children will receive will not be unearned, or investment income.

Peripherally, the kiddie tax rates also have changed for 2018. Assuming the child has no earned income, his standard deduction is $350 and the resulting total unearned income is taxed in the same way a trust or estate is taxed, rather than based on the parents’ marginal tax rate.

The next tax advantage is if your business is either a sole proprietorship or an LLC that is taxed as a partnership and owned by you and your spouse, you are not required to withhold or match any FICA or Federal Unemployment Taxes (FUTA taxes) for your children. Moreover, if after hiring your kids, your business has less than four employees, you are not required to have them covered for Workers’ Compensation. If you have more W-2 employees, you may apply for a waiver of Workers’ Compensation coverage for your kids in South Carolina.

If your business is either a regular “C” corporation or a Subchapter “S” corporation, the only way you can obtain the benefit of this tax-saving strategy is to jump through a few hoops and form a separate management company that operates as a sole proprietorship and would hire the kids.

The final tax goodie you will enjoy is that your children will be eligible to make contributions to a Roth IRA, since they will have earned income from their employment. Since none of their income will be taxable, a Roth IRA is the preferred approach, since there would be no tax benefit from establishing a regular IRA. The money that is contributed to the Roth will grow tax-free and will jump start their retirement savings plans.

Moreover, if need be, you could always withdraw tax-free dollars from the Roth, up to the amount of the total contributions that were made over the years, if you needed extra funds to pay for their college expenses. The earnings on your contributions would remain in the Roth IRA, however.

If you can afford it, I recommend establishing a separate Sec. 529 plan for college expenses, since you will receive a tax break on your S.C. income tax form for the contributions you make to that plan.

One ancillary benefit of employing your children is that you may jump start their business knowledge and get them interested more quickly in financial matters.