Children can be difficult, but they all become worth the trouble at tax season. From tax deductions to credits, there are many tax codes designed to lighten the burden for parents.
If you own a business, there is another way to save big using your children: by paying them and then writing off the expenses.
Kids and the family business
Family businesses are exempt from many of the laws that govern child labor. The government recognizes that parents will not subject their children to the abuses often seen in child labor; in addition, this is an essential part of teaching and passing on a trade. Not only is child labor allowed when the subject is your child, but it is actually encouraged by some tax laws.
There are several benefits to writing off your child’s pay. First, this keeps money in the family tax free. Second, you can teach your child a solid work ethic by having them earn the money for various things they want and need. Again, this money is a tax write-off, so you will come out ahead financially while teaching your child good values. While your child will have to pay taxes on any income they make over $6,200 a year, they probably will pay at a much lower rate than you pay. This is a solid win-win situation if you can play your cards right. There are, however, several criteria that you will need to meet.
Does your child qualify as an employee write-off?
There are a few criteria that your child must meet in order for you to write off their pay as a business expense:
- They must be performing services appropriate to their age and skill level.
- These services must exceed what a child is normally asked to do for their own parents and home.
- The child employee must be paid the going rate for their services.
- Good records must be kept, including W-2s.
- All federal laws regarding employees must be followed as they would be with anyone else.
If you can abide by these simple rules, you may be well on your way to a lower tax bracket.
Can you control how child employees spend wages?
This tax loophole is only a benefit if the child uses the money to pay for things that the parents would otherwise cover, such as clothing, pocket money, and car expenses. Is there a way to ensure that your kid continues to spend their hard-earned money responsibly rather than on a Lego or a Snickers bar?
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There are a few laws that pertain to this. First, using the child’s pay for their bare necessities may lead to tax trouble. The IRS expects you to provide the minimum needs of daily living for your minor children, above and beyond paying them. However, most parents also provide vacations, summer camp, name-brand sneakers, and other luxuries. These indeed can be paid for with your child’s tax-free earnings.
Another option is to put all or a portion of your child’s income into a Roth IRA. This tax-free pay can be used then to fund a car, college, and other expenses of early adulthood. Not only will you be reducing your tax burden, but teaching your child about responsible money management at the same time.
The downsides
There are a few downsides to using this plan to lower your taxes. First, it is a bigger money saver for freelancers and sole proprietors. S corps, however, still have to pay payroll taxes, even when the employee is their own child.