Deduction for Business-Owners with Children
One of the advantages of operating your own business is hiring family members. A family member can be a spouse, sibling, parent, or even a child. While this may not be on the forefront of many business-owner’s minds, there are many benefits to paying your child a wage, if done correctly.
Transfer Taxable Income
One of the more obvious benefits to paying your child a wage is income will be shifted from you as a parent to children. Shifting from parents potentially high tax rates to children’s 0% tax rate will save on taxes. With the Tax Cuts and Jobs Act increasing the Standard Deduction up to $12,950 (in 2022), children can receive up to the Standard Deduction and have 0% tax on their income. This would only apply to those children that do not already have taxable income from other sources.
Earned Income for Roth IRAs
In order to contribute to a Roth IRA, the individual must have earned income to qualify. When providing your children with wages for your business, it creates earned income that can be used to fund Roth IRA’s.
Roth IRAs are a unique retirement account that grows tax free and can be withdrawn tax free after the age of 59 ½ (assuming the account has been open for at least 5 years). You are also able to withdraw what you have contributed to you Roth IRA without being penalized or taxed. However, you may have to pay taxes and penalties on earnings for your Roth IRA.
Paying your children a wage will allow the opportunity for them to get started, at a really early age, to start investing in their retirement. The wages you pay your children can be used to fund these Roth IRAs.
No Medicare and Social Security Tax
Shifting taxes to your children at a 0% tax rate is a great benefit; however, an even greater perk to paying your children a wage is that you won’t need to pay payroll taxes on their wages. Payments for the services of your child under age 18 are not subject to Social Security and Medicare taxes. Unlike tax shifting, this only applies for certain entities. If the business is a parent’s sole proprietorship or a partnership in which each partner is a parent (excluding S-corporations and C-corporations) of the child and the child is under the age 18, then you are not obligated/required to pay the payroll tax. This means you wouldn’t need to issue a W2 for your child’s wages, but still retain all the benefits of paying your child a wage.
General Child Labor Laws
It is important to be mindful of both federal and state child labor laws. It would be best to check with your accountant before enacting any these tax strategy and to make sure you are compliant with any rules and regulations surrounding child labor. Equally, it is important to pay your children for work that is actually preformed within your business.
If you own a sole proprietor business (single member LLC) and have children that can help in your business, paying them wages is a great tax strategy for you. It will allow your income to be shifted over to your children at a 0% tax rate and you won’t need to pay the employment taxes (Social Security and Medicare).
