A column on personal finance prepared by the Virginia Society of Certified Public Accountants
THE TAX BENEFITS OF HIRING YOUR CHILDREN
(August 20, 2003) – Many small business owners dream of having their children join the family business. One of the best ways to make this dream come true is to get them involved at an early age. And, in addition to valuable work experience for your child, this situation can provide significant tax savings to the business.
According to the Virginia Society of CPAs, this hiring strategy works particularly well if the business is unincorporated and the children are under age 18. In these circumstances, the business is not required to withhold FICA taxes (Social Security and Medicare) or federal unemployment taxes. This means your business incurs no payroll taxes for your children and they get to keep more of what they earn.
The Rules Are Easy to Follow
The first rule to remember is that the work performed must be necessary to the business. Whether you’re paying the child to wash the company car or take a shipment to the post office, if it would be reasonable to pay someone else to perform this task, you can pay your child to do it. Just be sure the job reflects the child’s age and ability. For example, you might pay your 17-year-old computer whiz to do HTML programming for the company’s Web site, but assigning the same complex task to your 8-year-old may attract the IRS’s scrutiny.
CPAs say the rate you pay your child must be reasonable and consistent with what you would pay an outsider to do the same work. Also, be sure to pay your child with a check on a regular basis. To an IRS auditor, one large payment made at the end of the year may look more like an attempt to cut your tax bill than a legitimate effort to employ your offspring.
In general, treat the family member just as you would any other employee. This may mean your son or daughter punches a time clock, fills in a timesheet, or attends training classes like other employees.
Finally, keep good records. In case of an audit, you should be prepared to document the work that has been done and demonstrate that the amount you paid your child was reasonable.
IRAs Available to Children Who Earn Wages
Opening an Individual Retirement Account (IRA) for your child can boost their earnings. For 2003, a child can have up to $4,750 in earned income with no tax liability. By opening a traditional IRA, the child can earn an additional $3,000 of income and defer paying the tax. Consider opening a Roth IRA, particularly if your offspring may need to tap the account early, say for college or a first home. Since taxes are already paid on money put into a Roth, there will be no tax bill and no penalties if it’s withdrawn early for IRS-allowable expenses. Even if your children don’t use the money before retiring, the long-term tax advantages of Roth IRAs are usually better for younger savers since all withdrawals after age 59 ½ are tax-free.
Make the Most of This Win-Win Proposition
Hiring your children can help them learn not only responsibility and career skills, but also valuable money management lessons. The fact that working for you will allow them to keep more of their paycheck will be an incentive to do a good job and a great opportunity to understand taxes. A CPA can provide additional advice on how hiring your children can benefit your business and your family’s overall tax liability.
The Virginia Society of CPAs is the leading professional association dedicated to enhancing the success of all CPAs and their profession by communicating information and vision, promoting professionalism, and advocating members’ interests. Founded in 1909, the Society has nearly 8,000 members who work in public accounting, industry, government and education. This Money Management column and other financial news articles can be found in the Press Room on the VSCPA Web site at www.vscpa.com.
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