Employing Children in an Unincorporated Business

This tax-saving idea could help certain taxpayers reduce their federal taxes. If you operate a business as a sole proprietorship, a single-member LLC treated as a sole proprietorship for tax purposes, a husband-wife partnership, or a husband-wife LLC treated as a partnership for tax purposes, consider hiring your under-age-18 child, either full-time or part-time, as a legitimate employee of your business.

Your under-age-18 child’s wages are exempt from Social Security, Medicare, and federal unemployment taxes. In addition, your child can use his or her standard deduction to shelter up to $5,950 of 2012 wages from federal income tax. Under this arrangement, your child will probably owe little or no federal income tax on the first $5,950 of wages. He or she can set aside some or all of the wages and invest the money. Hopefully, the cash stash will eventually be used to help pay for college, which means less stress for you.
Meanwhile, as the employer, you can deduct the wages paid to your child as a business expense, as long as they are reasonable for the work performed. The write-off will cut your income tax liability and your self-employment tax bill (if applicable). The write-off will also lower your adjusted gross income, which will decrease the odds of getting hit with the unfavorable phase-out rules that can reduce or eliminate various tax breaks.

After your child reaches age 18, Social Security and Medicare taxes will kick in; however, federal unemployment tax will not apply until age 21. The child’s standard deduction will still shelter up to $5,950 (for 2012) from federal income tax. And, you can still deduct the wages and related employment taxes as business expenses.

Even if your business is incorporated, hiring your child can still make tax-saving sense. In this scenario, the child’s wages are subject to Social Security, Medicare, and federal unemployment taxes regardless of his or her age. The good news is the child’s standard deduction still provides an income tax shelter for the child, and the corporation can claim business deductions for the wages and the employer’s share of the employment taxes.

Please contact us if you have questions or want more information about this strategy.


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