Hiring Your Children is Good Business
When you pay your children reasonable wages to work in your family business, you provide your offspring with valuable knowledge and get a few special tax breaks in the process. If you’re a business owner, you’ll want to read what the Texas Society of CPAs has to say about hiring your children.
THE TAX IMPLICATIONS
In 2016, you can pay your child up to $11,800 (standard deduction equal to earned income up to a maximum of $6,300, plus $5,500 deductible IRA contribution) without either of you incurring a tax liability. That’s because reasonable wages you pay to your minor child to work are fully deductible as a legitimate business expense, lowering your gross income. For your son or daughter, the standard deduction and IRA contribution eliminates all of the tax on the child’s income. And since the money was earned, the “kiddie tax” doesn’t apply even if your child is under age 24.
Here is an example of how much you can save. Suppose you’re in the 33 percent tax bracket and you pay your 17-year-old son to help with office work full-time during the summer and part-time into the fall. He earns $11,800 during the year (and doesn't have earning from other sources). If that $11,800 otherwise would be paid to the business person, he or she saves $3,894 (33 percent of the $11,800) in income at no tax cost to the son.
Income tax withholding
Regardless of how the family business is organized, it probably will have to withhold federal income taxes on the child's wages. Usually, an employee who had no federal income tax liability for the prior year, and expects to have none for the current year, can claim exempt status. However, exemption from withholding cannot be claimed if (1) the employee's income exceeds $1,050 for 2016 and includes more than $350 for 2016 of unearned income (such as dividends), and (2) the employee may be claimed as a dependent on someone else's return (whether or not he actually is claimed). (Instructions to Form W-4 for 2015) Keep in mind that the child probably will get a refund for part or all of the withheld tax when he or she files a return for the year.
An employee may be able to claim exemption from withholding even if he or she is a dependent, if the employee is age 65 or older; blind; or will claim adjustments to income, tax credits, or itemized deductions on his or her income tax return.
FICA and FUTA: Employment for FICA tax purposes doesn't include services performed by a child under the age of 18 while employed by a parent.
This can generate some savings for a parent who runs an unincorporated business. For example, let's say a sole proprietor who usually takes $125,000 of earnings from the business pays $4,750 to her 17-year-old child in 2016. The sole proprietor's self-employment income would be reduced by $4,750, saving her $137.75 in social security taxes. This doesn't take into account a sole proprietor's income tax deduction for one-half of his or her own social security taxes. That's on top of the $363.37 in employee FICA that the child saves by working for Mom instead of someone else.
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. The FICA and FUTA exemptions also apply if a child is employed by a partnership consisting solely of his parents.
However, there is no FICA or FUTA exemption for employing a child in an incorporated business or in a partnership that includes non-parent partners. The children are subject to the same rules that apply to all other employees.
CONSULT WITH A CPA
Everyone’s financial situation is different. A CPA can help you identify the right course of action for your business and your family.
(Updated 2017) Reviewed and edited by Ryan Bartholomee, CPA, Shenandoah Petroleum Corporation