Shift Business Income to Lower Taxes

If you have children who can work for you on a part-time basis or during the summer, you may be able to turn high-taxed income into tax-free or low-taxed income.  It may even be possible to save on social security taxes and make retirement contributions for your child.

The work that the child performs must be legitimate, and the compensation must be reasonable for your business to deduct the wages as a business expense.

Take for example, a sole proprietor in the 35% tax bracket who hires her 16-year-old son to help with office work full-time in the summer and part-time in the fall. He earns $5,450 during the year and has no earnings from other sources.  Since her son can use his $5,450 standard deduction for 2008 to completely shelter his earnings, the business owner saves $1,908 (35% of $5,450) in income taxes without costing him a penny.

If the business owner keeps her son on the payroll for a longer period of time and pays him $5,000 more, she could save an additional $1,750 in taxes, and still not cause her son to pay any tax, provided he contributes $5,000 to a traditional IRA. Even if her son’s earnings exceed his standard deduction and IRA deduction, her taxes are cut because the unsheltered earnings will be taxed to the child, whose tax bracket starts at a rate of 10%. 

By shifting some of your earnings to your child, you can also save some self-employment (SE) tax dollars if your business is not incorporated. This is because wages paid to the child are part of the business expenses and reduce your net income on which SE tax is based.  However, you will not have a deduction for the employer’s portion of FICA tax on the child’s wages since you will not have paid this tax. Employment for FICA tax purposes does not include services performed by a child under the age of 18 while employed by a parent.  A similar but more liberal exemption applies for FUTA, which exempts earnings paid to a child under age 21 while employed by his or her parent.  Both the FICA and FUTA exemptions also apply if a child is employed by a partnership consisting solely of his or her parents.

In addition to the potential tax savings of bracket-shifting, your business may also be able to provide your child with retirement benefits.  This depends on the type of plan your business has and how it defines qualifying employees. 

Take into consideration that some of the rules about employing children change on a yearly basis, which may result in some strategy shifts as well.  Please call our office to find out if these rules apply to your situation.

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