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What are the Tax Benefits of Hiring Your Children?

October 08, 2020

Has the COVID-19 pandemic impacted your business financially? You might benefit from hiring your kids. This is a tax-savvy move that could help your business significantly. Here are the details.

COVID-19 has put extreme financial pressure on small businesses, but there may be an opportunity to save if you hire your children or relatives. With delayed and/or virtual schooling, your children may find themselves with more free time to help with the family business which can leave you with easy tax benefit opportunities.

There are a couple different approaches you can take depending on what type of business you run (sole proprietorship, husband-wife partnership, s-corp, and c-corp) and how old your child or relative is. Here, we will break down each situation and how to take advantage of the potential tax savings.

Who qualifies as a relative?

For purposes of these rules, a “relative” includes spouses, sons, daughters, adopted children, foster children, and stepchildren. Throughout this article, I will be talking specifically about hiring children.

Sole Proprietorship and Husband-Wife Partnerships

  • If you’re hiring your child who’s under 18, their wages are exempt from Social Security, Medicare taxes (FICA tax), and Federal Unemployment Tax (FUTA tax), meaning more money in their (or your) pocket.
  • The FICA exemption applies to the employer’s share of FICA tax as well (even more savings!)
  • Your child is also covered by the standard deduction of $12,400 meaning they will most likely not being paying tax at the federal level.

S or C Corporations

If you’re hiring your child (regardless of their age) their wages are subject to FICA and FUTA taxes just like any other employee. But, don’t forget, they still won’t be paying federal tax on up to $12,400 thanks to the standard deduction ($24,800 for a joint filer and $18,650 for head of household filer).

What Should I Be Doing With This Extra Income?

Your next question may be, “what’s the best way to use this extra income?” With your child bringing in income and your business benefiting from the wage deduction, there are a couple things we suggest you do. First and foremost, you can save. With COVID-19 leaving business financially stressed, the extra income may be needed to make ends meet. On the other hand, if you don’t find your family in a financially stressed situation your child can use all or a portion of their earnings to fund a college savings account, contribute to a ROTH IRA, or contribute to a traditional IRA.

Your child can contribute up to $6,000 each year to a traditional IRA and in turn get a $6,000 tax deduction. In addition, your child can receive a tax credit up to 50% of their IRA contribution (not exceeding $1,000) if their income is under $19,501.

If you expect your business to be unprofitable this year, your child’s wages can be deducted to create or increase a Net Operating Loss (NOL) for 2020. The CARES act allows NOLs arising in 2020 to be carried back for up to five years (more tax savings!) Check out our blog, How does the CARES Act Impact NOLs?

Hiring your children during these times can lead you to pay less tax and create more income for your family. It is important to pay and document your child’s wage and duties as you would any other employee by keeping payroll records and issuing W-2s at year-end. For more information about this topic, please contact us.

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