Putting Your Kids on the Payroll
If you could use a little help for your business this summer, there are some good reasons to recruit your own offspring. First and foremost, it’s a good opportunity for teens and college students to earn money for their own expenses while gaining valuable work experience for the future.
Involving children in the operation of a family business might also inspire and help prepare one or more members of the next generation to take over when their parents are ready to retire. Last but not least, parents who employ their children enjoy access to several lucrative tax benefits.
Taxes, Taxes, Taxes
When a child under age 18 is employed by a parent who owns an unincorporated business, the child’s wages are not subject to Social Security and Medicare taxes (FICA), which add up to 15.3% (for employee and employer) in 2016. If the child is under age 21, there is an exclusion from the federal unemployment tax (FUTA). Of course, children’s wages are still subject to income tax withholding.
Even if your children are too old to qualify for these favorable payroll or unemployment tax breaks, you can deduct the wages you pay them as a business expense. This shifts income from your tax bracket to their lower one, and no income tax will be owed on the first $6,300 they make because of the standard deduction. Wages are earned income, so the “kiddie tax” does not apply. Children subject to the kiddie tax are generally taxed at their parents’ tax rate on any unearned income over a certain amount.
Your child’s earnings are deductible only if he or she performs real work (not household chores) in connection with your trade or business, payments are actually made, and the wages are reasonable for the services rendered.
The Roth Opportunity
A child with earned income can also contribute to a Roth IRA ($5,500 limit for 2016). A Roth IRA can be a flexible way to save for college, retirement, and other needs.
Because contributions to a Roth IRA are made on an after-tax basis, they can be withdrawn without penalty at any time, for any reason. Normally, there is a 10% penalty for early withdrawals of earnings before age 59½, but there are a couple of handy exceptions. For example, a penalty-free distribution can be used to pay qualified higher-education expenses or to purchase a first home ($10,000 lifetime maximum).
Qualified withdrawals of earnings from a Roth IRA are tax-free, regardless of how much the account grows over time. A qualified withdrawal is one that meets the five-year holding requirement and takes place after age 59½, or that results from the owner’s death or disability.