Can I Reduce Taxes By Paying My Kids?

Absolutely!! Among the tax strategies that small business owners with families today underuse the most must be this one. Paying their children under the age of 18 is a great way for parents to reduce their tax liability, and it also has a number of other benefits that many are unaware of.

One of the tax strategies that small business owners with families today should use the most sparingly is to pay their children for working for the company. It's crucial to compensate your kids for their services if they work for you in the company, regardless of their age. One of the best ways to reduce taxes is by paying your kids.

Many people are unaware that giving your kids the money they deserve is a great way to reduce their tax burden. Not to add, it generates a plethora of additional side benefits. But if it's not handled correctly on the "books" and "tax return," there may be an audit risk. There are two different categories of benefits that I will discuss 1) Non-Tax Motives and 2) Tax Motives.

Non-Tax Motives

1. All across America, mainly do to robotics the "normal" summer jobs are going away. The rise of self-checkout, and robotics cooking fast food an increasing number of kids are growing up without a work ethic, knowledge of money management, or an understanding of entrepreneurship. You may be able to teach them more about future financial success or even business ownership if you involve them in the company.

2. How many of you wish you started saving for retirement earlier? I know that I do. The ability to contribute to your children's retirement accounts at any age is a significant additional benefit. Whether you want to start a Roth IRA for a child under the age of 10 that will eventually grow exponentially into millions of dollars, or you want to assist a 30-something who needs to start a 401(k) and learn that it's "better late than never" to start saving, you should do both.

3. It can be challenging to find qualified employees and get assistance in the business these days. Many small business owners overlook the fact that some of their most inexpensive labor is provided by employees who are seated at the dinner table in their own homes. Engage them in the company and give them somewhat more control over their schedule than you would with other "outside" workers!

Tax Motives (this section will be a bit longer)

Kids under the Age of 18

There are two reasons why the tax benefit for children under 18 is so attractive. It is crucial to comprehend these features, and I cannot stress this enough.

First off, you are not required to withhold any income taxes or payroll taxes from payments you make to children under the age of 18 (that's the "F" word I'm talking about: FICA). (See IRS Pub No. 15, (2011), p. 10, IRC Code Sec. 3121(b)(3)(A), IRC Reg. Section 31.3401(a)(4)-1(b), and This holds true for workers' compensation as well in most states. Be sure you look up the rules for your state.

Yes, you are correct. This is the general rule and justification for Workers Compensation in nearly all states: there is no federal payroll tax withholding on your own children. This is because, hopefully, neither the government nor the insurance companies will presume that your kids will sue you if they get hurt at work. You will pay the bill in one way or another, and they are most likely covered by your health insurance plan as well.

Second, the first $13,850 of income in 2023 will be tax-free for all Americans, including our kids!

Furthermore, if you've never heard of the "Kiddie Tax," it doesn't apply to "earned income," and you can continue to claim your kids as dependents on your tax return and use the child tax credit. However, the child is exempt from paying taxes on the first $13,850 of their earned income! The "Kiddie Tax" is simple to avoid, and I don't want my clients to pay it.

Kids 18 and older

If you are continuing to "support" an adult child and enlisting their assistance in running your business, this is a crucial and effective tactic. In this scenario, you basically have two choices.

1. Pay them in accordance with W-2 procedures along with all other "rank and file" employees, or

2. Pay them under contract and provide an accurate Form 1099-NEC

It is crucial that you abide by state and federal laws when dealing with contractors and employees. Avoid pressuring them to give you a 1099. If your kids behave, dress, and smell like employees but you "call" them subcontractors, you could be easily caught in an employment audit. Take caution.

I have observed three main methods over the years that you can use to include your adult children in your company.

1. Ask them to provide off-site marketing consulting and services. This might be as simple as doing sporadic management or marketing support, regular social media postings, or graphic design.

2. Ask them to join your LLC's board of advisors or your corporation's board of directors. This is incredibly common and offers business owners excellent support. It serves as a tool for educating kids about business as well.

3. Assume the role of property manager for your rental property in your children's neighborhood. It's possible that they are genuinely renting this while attending college.

Step to Take for Audit Purposes

It Has To Be EARNED INCOME

Here's the tactic: Where do the children receive their earnings? Paying your children a fair wage for work and services they perform for your business—YOUR business, ANY business—you take a tax deduction for (operational or rental). By deferring income to your children, you thereby create a great tax-deductible expense for your income taxes (within your business).

Naturally, I'm not in favor of paying your kids to be "shams." They must be properly engaged in the business, and you should pay them a fair wage and maintain documentation of the hours they put in. Hiring your kids to perform 'family chores' on their own won't qualify as a legitimate deduction and will undoubtedly put you on the audit trail.

Here's how it works: Paying wages to children under 18 is permitted by the IRS for any sole proprietorship or partnership (LLC) that is fully owned by the child's parents. This avoids the need to withhold payroll taxes and record the payment as "outside labor" as an additional expense. AVOID Payroll. It is not necessary to provide a W-2. This is so because the penalty for failing to file a W-2 is determined by the "withholdings" and there are no withholdings. However, notice that there are no withholdings.so no fine...and the W-2 is therefore unnecessary.

If a W-2 is present, it makes no difference to the IRS because no FICA, FUTA, or SUTA are owed or withheld. We only advise a W-2 if you intend to have your child make contributions to a Roth IRA—which is a fantastic plan, by the way. In those cases, we want the child's IRA contribution and their earned income to line up on the IRS computer. You won't be penalized if you don't, but it would be good to maintain the IRS computer system's happiness.

Please Note: The benefit of avoiding FICA when paying your children under the age of 18 is not available to you if your corporation is a S or C-Corporation. Unless you funnel the funds through a single "management company," that is. Payroll taxes must be withheld if you pay your kids out of a corporation. Therefore, we advise you to pay your kids through a family-run management company (sole prop). You accomplish this by paying a legitimate management fee to the sole-prop from the S-Corporation and then paying the kids out of the Sole-Proprietorship or Single Member LLC as "outside labor" (an "other expense").

In Conclusion

Let's outline the advantages of employing your kids for the company:

1. Paying your children the money you were going to give them anyway earns you a tax deduction

2. The first $12,550 of your child's income is still not subject to income tax in 2021

3. If the kids—young or old—pay taxes, they usually do so at a lesser rate than yours

4. This could apply to a rental property, an online business, or even an operational one

5. It's not necessary for them to live close by for it to be accepted

6. Youngsters are taught about entrepreneurship

7. And if you're lucky, their assistance will really increase the profitability and success of your company

I have witnessed these tactics not only help clients save thousands of dollars on taxes, but also genuinely transform their families' lives. Youngsters start learning about work ethics, which has the power to unite a family in ways that small business owners could never imagine.

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