Here’s a strategy that will allow you to hire your children in your own business and reap multiple benefits. This strategy might be for you if you want your business to become an asset to your children’s upbringing. Your child could have the benefit of learning real-world work and business skills and developing a strong work-ethic. What’s even more, you and your business can benefit from having an extra pair of hands to help. You get the advantage of deducting what you pay them through your payroll, shifting the income to their lower tax bracket; and all the while you’ll be potentially avoiding additional payroll taxes.
Shifting Your Income to Your Child's Lower Tax Bracket
You’ve hired your 11-year old daughter in your Japanese deserts business to do some of the baking along with helping with parts of the bookkeeping. She’s getting skills that will help her throughout her life and she’ll learn “the value of a dollar earned” as the old phrase goes.
Let’s say you’re at a 30% tax bracket and your paying your daughter $6,000 through payroll that year. Since the standard deduction is $13,850 for her in 2023, your daughter won’t have to pay income taxes on the $6,000. With shifting this income, you’re saving $1,800 in taxes that you would otherwise be paying at your 30% bracket.
Additional Advantages of Hiring Your Children - Avoiding Social Security, Medicare, and Unemployment Taxes
This won’t work if your business is incorporated (C Corp, S Corp). This applies if you own your business as a sole-proprietor or partnership, whether through an LLC or not.
If you’re a parent who’s hired his child under the age of 18, you’d be exempt from paying certain taxes. Namely, these are Social Security, Medicare, and unemployment taxes, also known as FUTA (Federal Unemployment Tax Act) and FICA (Federal Insurance Contributions Act) taxes.
From FICA alone, this is saving you 7.65% that you would otherwise have to pay on the wages of your child. Then, it is saving your child’s income from an additional 7.65% withholding to pay the “employee part” of Social Security taxes. That’s a whooping 15.3% savings on taxes (employer and employee combined).
Again remember, if your a corporation, you have to pay Social Security and unemployment taxes on everyone under payroll. So this benefit will not apply in that case. You’re still able to hire your children, but you’d be relying only on the tax-bracket differential (income shifting) to produce a benefit.
Think about what $1,800+ tax savings a year -in our Japanese deserts example- could do for you and your family. That’s in addition to the savings from avoiding Social Security and Unemployment taxes. You could put that toward paying for your kid’s college education, their wedding, or their future in general.
You could really go up to the full amount of their standard deduction ($13,850 in 2023) and save more than $4,155 a year in taxes. However, the pay must be reasonable and you must make every effort to document it.
Take the steps on how to hire your children just as you would another employee (except the recruitment and screening). For example, draw up a employment contract just the same. Make sure you’re filing all the required docs, such as the payroll documentation, and the following forms if necessary: IRS Form W-4, IRS Form W-2, IRS Form 941, IRS Form 940.