Hiring your children within your business or practice can provide both you and them many benefits. If you are running a business and have kids, then you should review this as a viable strategy. Here are 5 reasons you should hire your children within your business or practice.
1. They can earn $12,400 (2020) in Wages Federally Tax Free
With the new tax law your children can earn up to $12,400 without having to pay federal taxes. Depending on how your practice or business is setup (C-Corp, S-Corp, PLLC, Partnership), the tax consequences for payroll taxes can vary.
Most practices are likely being taxed as an S-Corp. Let's say that you own a business that is a PLLC and taxed as an S-Corp. You hire your child and pay them $10,000. You will have to pay 15.3% in FICA payroll taxes + $200 in other taxes (FUTA, State Unemployment). You are married and your joint income is $300,000, you would be in the 24% marginal federal tax bracket. (Not including state income taxes)
Child's Payroll Your Taxes
$1530 Payroll Taxes ($10k * 15.3%) $2400 Total Taxes ($10k * 24% Tax Rate)
$200 Other Taxes
$1730 Total Taxes
Tax Savings = $670
Remember this is per year. If you don't feel that alone is worth it then keep going.
2. It gives them the ability to open a Roth IRA
The tax savings alone may not feel entirely worth the effort to put your children on payroll. But coupling the tax savings with a Roth IRA for your children adds another layer of benefit.
What are the requirements for a Child to have a Roth IRA in their name? They must have earned income. By hiring your child(ren) you have now provided them earned income and the ability to open a Roth IRA.
The Roth IRA is known to be one of the best investment vehicles available. Money is invested after you have paid taxes on it, it grows tax deferred and when they withdraw the money in retirement it comes out tax free.
Let’s do some quick math to see if it’s worth it.
You pay your child $5,000 per year until they are 18 years old. You invest the after tax portion into a Roth IRA.
$965 (Payroll Taxes 15.3% + 200 in Other Taxes)
$4035 Net Pay
Invest $4,035/ year until your child reaches 18. Assuming on average the investment earns 7%. At 18 their Roth IRA would be worth $144,829.95.
Let's assume they added no more money to that Roth IRA and left it to keep growing at an average rate of 7% per year. At age 60 they would have $2,716,279 in a Roth IRA and could withdraw it 100% tax free throughout retirement.
Even if you waited until your child was 10 for them to start working within your business, making the same assumptions as above they would have $43,106 in their Roth IRA at 18 and $808,451 at age 60.
3. You don’t lose the Child Tax Credit on your Tax Return
With the new tax law there is no personal exemption anymore, but there is a child tax credit. The income limits were increased and you don't start to phase out until you reach $400,000 (Joint Filing) or $200,000 (single). The child tax credit is $2,000 per child. That’s not a deduction either, its a tax credit so it's an actual $2,000 in tax savings. Even though they have earned income up to $12,400, you are still able to get this tax credit.
4. They can use those Wages and / or Roth IRA to Pay for College
Most families in a high tax bracket can’t get a tax deduction for college tuition as the phase out happens at $180,000 (Filing Jointly). Let's say your child works at your business over the summer or manages your social media platforms remotely. By paying them wages you are essentially shifting the wages from your tax bracket to their tax bracket. Depending on your entity you're still paying payroll taxes, but that money can be used for college essentially shifting some income to them by paying in a lower tax bracket. This strategy may or may not be best at the time of college as you have weigh many factors including aid, loans, cost, etc.
They also can use the Roth IRA to pay for college. In a Roth IRA you can withdraw the principal without incurring any taxes or penalties. Let's say your child worked starting at age 10 and at age had $43,106 in their Roth IRA. They would have contributed $32,280 and that can be withdrawn for any reason with no penalties or taxes.
5. It Teaches Them about Work and Money
By hiring your children to work in your business, it teaches them work ethic along with watching you work or seeing what you have built. By taking some or all of what they earned working for you and investing in a Roth IRA it will also teach them about savings and how compounding interest works when you invest over time.
There isn’t much taught about money to children in schools as they grow up. Those teachings will be left to you and your spouse. With technology, instant gratification, and easy credit those early money lessons can make a real difference on how they view money when they become adults and no longer listen to your wise lessons.
When it comes to hiring your children and like many other tax strategies, the key is to document, document, document. Remember like most tax deductions you may have to prove and explain it one day. and documentation is key.
Hiring your children as models from when they are first born to 18 and they don’t step foot in your business(other than their picture) and paying them $12,400 likely won’t pass the reasonable test.
Follow these simple rules,
Document what they do and how much they are paid
Pay them a fair market wage (Paying them $100 per hour to sweep floors doesn’t work)
As they get older so can their jobs meaning they may start out modeling on your brochure, move up to cleaning your office or managing your social media platforms and then learn how to place crowns. Ok maybe placing crowns will have to wait until they follow in your footsteps.
It may seem that paying your children may not seem worth it if you break it down to just saving on taxes in one year. But if you add up all of the reasons and view it over a 5, 10 or even 18 year period then putting them on payroll can really add up.
If you are looking for a CPA to help with tax strategies like these, contact us today.