At Ferguson Timar we serve many clients who own businesses. The entrepreneurs we work with are eager to improve the tax treatment of their companies to improve the bottom line both for their businesses and for their families. In recent years important changes to the tax code have created a new opportunity for business owners to simultaneously create a source of income for their children and a tax benefit for their companies.
Why hire your kid?
Many business owners don’t know they are allowed to hire their kids as employees. The IRS even encourages it. Giving your child a job is not just a great way to teach them important lessons about work and business. It also gives them a way to earn money—with potentially long-term benefits— while also giving your business a deductible expense.
Hiring your child as an employee can be a valuable financial strategy. Many business owners plan to provide financial support to their children when they go to college. Instead of simply giving the money to their children, they can instead hire them, transforming a gift with no tax benefits into wages that become a deductible expense for the business.
Tax consequences for the kid
The first concern many parents have when they think about whether to hire their children is whether it will create a tax liability for the kid. A child is required to file a tax return in a few situations:
- The child’s unearned income from things like dividends exceeds $1,100 in a year.
- The child’s earned income from working is more than the standard deduction, which for 2020 is $12,400.
- In rarer cases, the child owes employment taxes, perhaps because the employer was not withholding them, or other forms of tax.
The Tax Cuts and Jobs Act of 2017 (TCJA) essentially doubled the standard deduction, which makes this an especially great time for children to earn money from jobs.
Teenagers usually have plenty of ideas of how to spend the money they earn. We recommend parents encourage their kids to contribute to a Roth IRA. The contribution limit for the 2020 tax year is $6,000, but kids can begin building toward retirement by contributing any amount. By starting a Roth IRA early and investing wisely, a child can start reaping the benefits of compounding returns.
Tax consequences for the business
Most businesses that hire a child can claim the wages paid to the child as a deductible expense. All businesses are required to comply with tax withholding rules, which will apply to the child employee. Other details of the tax treatment of hiring a child as an employee vary according to how the business is organized:
- Pass-through entities (other than S corporations)
A pass-through entity is a business organization that is not treated as a separate taxpayer from its owner. These include sole proprietorships, single-member LLCs that are not treated as corporations, and partnerships or LLCs that are owned by a married couple and that meet IRS rules. Note that S corporations can be pass-through entities for other purposes, but because they are corporations they don’t qualify for this benefit. A qualified pass-through entity can hire a child who is under 18 years of age without being subject to employment taxes, including Social Security and Medicare taxes and federal unemployment tax.
- Corporations and tax-regarded entities
Corporations (including both C corps and S corps) and other tax-regarded entities don’t have the same advantages as pass-through entities. A corporation must pay employment taxes (Social Security, Medicare and federal unemployment taxes).
Leverage your business to do more for your family
Bear in mind that hiring your child as an employee may have other consequences depending on the particular circumstances of your business and the work being done by the child. For example, the business may be required to provide the child with workers’ compensation coverage.
The professionals at Ferguson Timar are here to guide you through the pros and cons of having your business hire your child. Are you ready to learn more? Give Ferguson Timar a call today to schedule an appointment.