Children: Your Most Valuable Employees and Write-Off

Mark Kohler CPAby Mark J. Kohler, CPA, Attorney at Law

This has to be one of the most under utilized tax strategies by small business owners with families today. Many don’t realize that paying their children under age 18, as well as adult children or grandchildren, is an excellent strategy to minimize their tax liability, not to mention it creates a host of other ancillary benefits.

The days of the farm are continuing to disappear all across America and more and more children are leaving the home without work ethic, money management skills and a concept of entrepreneurship. Moreover, many small business owners forget that some of their most affordable labor is right there in the house with them eating at the dinner table. Get them involved in the business!!

The beauty of the tax benefit is two fold. First, when you pay your children under 18, you don’t have to withhold any payroll taxes or even carry Workers Compensation Insurance (we don’t assume our children will sue us if they are hurt on the job- at least we hope not).

Second, all of us, including our children don’t pay taxes on the first $5,700 this year. It’s the Standard Deduction! You can still claim your children on your tax return as a dependent and take the exemption, even the child tax credit, however, they don’t pay taxes on their earned income on the first $5,700.

Therefore, when you pay your children for services they perform in your business you are able to generate an expense for your income taxes by pushing income to your children. Now of course, I’m not advocating you pay your children as a ‘sham’ operation. That have to be legitimately involved in the business and you want to keep records of their time worked, as well as pay them a reasonable wage.

Here is the procedure, and it’s important you follow the write procedure or it could backfire on you!

The IRS allows any sole proprietorship or partnership (LLC) that is wholly owned by a child’s parents to pay wages to children under age 18 without having to withhold the payroll taxes. However, if you have an S or a C-Corporation you do not receive this benefit of avoiding FICA when paying your children. Don’t pay your children out of a corporation, or you have to withhold payroll taxes.

Thus, we recommend you pay children out of a family management company paid a management fee from the Corporation, or simply pay them out of a Sole-Proprietorship or LLC with independent income and operations.

If you are paying children over age 18 or grandchildren, you have the option of treating them as a sub-contractor or employee, but you will have to withhold FICA and other typical payroll fees if they are an employee.

Mark J. Kohler, CPA, Attorney at Law and Author of the Best Selling Book Lawyers are Liars- The Truth About Protecting Your Assets and his new book What Your CPA Won’t Tell You. For more information visit www.markjkohler.com.

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