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Family Employee Tax Breaks Legal Tax Angles: How to Save Taxes Without Going to Jail If you own a business, whether part time or full time, you may be able to transfer some income from your higher tax bracket to your children’s lower bracket tax return by hiring them to do some work for you. If you are audited by the IRS, you should be prepared to show them some proof that your child or children really did some work for you and the amount you paid them was reasonable in relation to what they did. If you want to be moderately aggressive, you could reasonably argue that they should be paid the same as a temporary employee who might be hired to do the same work. However, paying them to do nothing - or paying them a clearly excessive hourly rate - is likely to backfire on you eventually. Meanwhile, while nepotism might be discouraged by management consultants, it’s good tax planning. First, you can deduct their wages as a business expense. Assuming your business is not incorporated, you are not required to withhold or to pay any taxes on their compensation, including social security or Medicare taxes or unemployment taxes. Meanwhile, the amounts you pay to your children for wages will reduce your profits for income taxes and for self employment taxes (unless you are making over the maximum covered amount). Second, they can offset those wages against the standard deduction of $4,750 each for single taxpayers, and the $3,050 dependent’s exemption. Then, the next $28,400 of any earned income is taxed at a 10% or 15% federal tax rate. (If your child claims the dependent’s exemption, you can’t also claim it). The test for payroll tax free compensation to a child does not require that the child be a dependent - but the child must be under 18 years of age. The Roth IRA would be of special value to children in a zero or 10% tax bracket because they could contribute up to $3,000 a year to the IRA with future tax free income and gains. If needed, part of that money could be withdrawn for education expenses without penalty or used for the purchase of a home (up to $10,000) without the 10% penalty tax. For estate tax purposes, the money you pay to your children also reduces the amount that you are likely to have in your estate. If your business is a partnership or is incorporated, hiring your children becomes less profitable. Your corporation will have to withhold income taxes and social security taxes on their pay. The corporation would also have to pay federal and state unemployment taxes on the amounts you pay them, at whatever rate you are paying for other employees. However, any income your children receive from your corporation is still going to be taxed at a lower bracket than if the income was paid to you. Vern Jacobs Copyright, 2003 |
Books and Services by Vern Jacobs
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