According to the U.S. government, the average cost of raising a child from birth to age 18 is about $233,610. That’s a significant sum, almost a quarter of million dollars for one child.
If you have a large family or are planning on one, the cost could run into seven-figures. And that does not even include the skyrocketing cost of a college education these days.
By making your kids employees, the expense can become deductible to you and your business if approached correctly. In fact, hiring family members is a practice that the Internal Revenue Service (IRS) endorses as a benefit to the business owner.
Basic Rules to Keep in Mind
The requirements are somewhat different than hiring a regular employee so let’s review the basics here.
- Hiring a child under 18 who works for his or her parents in a trade or business is NOT subject to social security and Medicare tax withholdings if the trade or business is a sole proprietorship or a partnership in which each partner is a parent of the child.
- A child under the age of 21 who works for his or her parents is not subject to the federal unemployment tax act, or FUTA.
- Payments for the services of a child are subject to income tax withholding regardless of age, but everyone who earns income gets a standard deduction of $12,550.
- So, each child can be paid up to $12,550 with no FUTA or FICA and, when he or she files a return, there is NO income tax obligations if their salary is under $12,550. As the business owner, you will write off the amount you’ve paid your children in wages on your business return.
- However, if you hire your children within your corporation, even if it is controlled by you as parents, or a non-parent partnership if only one parent is the partner, any salary paid to your child is subject to income tax withholding as well as social security, Medicare, and FUTA. The same rules apply if your child works for an estate, even if it is the estate of a deceased parent.
To recap, if you own a business, you can hire your kids. Just remember that if it’s a parent only owned business taxed as a sole proprietorship or a partnership, the money you pay your children could be taxed as low as 0%.
If you own a corporation and pay your children, they will be subject to FICA, but they still are in a lower tax bracket than you so you will still be lowering your federal income taxes.
Now, let’s cover how to properly document the process of hiring a child for your business.
How to Properly Document Your Child Employee
The first step is to make sure there is a job or service in the company that your children are qualified to perform, so that you can pay them wages.
Once you have identified a need, you should create a job description or job duties.
The most important part of this process is making sure the job you hire your child for is age appropriate.
A suitable wage must be determined for the job you are hiring your child to perform. You can look at standard pay grades for entry-level positions. You cannot pay your child more than you would pay an unrelated party to do the same job.
We strongly suggest you do not pay your child $50,000 for occasional office cleaning. Almost certainly this would be a red flag with the IRS. Always remember the key to hiring your children is the wage needs to be a reasonable wage for reasonable work.
It is very important when you make the decision to hire your children, that your children actually do the work they have been hired to do. The IRS has caught business owners who claim to pay their kids for working when they were not.
Important Guidelines to Follow
If you properly follow the rules and recommendations found below, you should have no problem documenting that your children are working for your business.
- Have a hiring agreement on file to properly document the employment of your child.
- Open a custodial bank account for your minor child to create a paper trail.
- As with any employee, your child should log his or her time to prove the work accomplished.
- If your business is a sole proprietorship or partnership with only your spouse, and your child is under 18 years of age and being paid less than the standard deduction of $12,550, he or she will not be subject to withholding. Payment should be made with a company check.
Custodial Roth IRAs and Whole Life Policies for Your Children
Once you have taken these steps and followed the proper documentation to add children to your company payroll, you both have several additional financial and tax-saving options to take advantage of.
First, opening a custodial bank account for your kids, with you managing the account, creates an important paper trail to document their employment. You can use the custodial account to pay for expenses that would have originally come out of your disposable income.
The custodial account can be used for anything that is in the best interest of your child. The account can even be used to fund a 529 college savings plan for their future education.
Second, consider opening a Custodial Roth IRA account for your child. All assets in the account are managed by you as custodian until your child reaches the “age of majority,” usually 18 years old (or 21 in some states).
All funds in the account belong to your child, and in addition to reaping the benefits of tax-free compounded growth, your child may be able to use the funds for future expenses like college tuition or to buy a first home penalty-free.
Third, also consider establishing a whole life insurance policy for your child using the money he or she earns on the job. There are several key advantages to starting early you should be aware of.
With many insurance carriers you can lock-in a low, childhood premium on the policy that will never go up as long as the premiums are paid. Also, many whole life plans build cash value with each monthly premium payment.
This helps create another source of savings. Your child can borrow against the cash value to cover expenses later in life. This includes college tuition, starting a business of their own or getting married, among other things.
Bottom line: If you own your own business, you can realize many benefits of hiring your kids. Not only will you have the satisfaction of working alongside your children and teaching them to be responsible workers. But there are significant tax-saving and wealth-building advantages for both you and your kids. To find out more about the many advantages of employing your kids, contact TSP Family Office at (772) 257-7888.