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Putting Your Kids on the Payroll
By Jason Watson, CPA
Posted Tuesday, October 12, 2021
Should you pay Junior to vacuum? Perhaps. While most parents can’t get their children to clean a counter or put away dishes, perhaps putting them to work at the office is a good option.
There are some minor tax advantages to paying your children- for example, you can pay your child $12,000 in wages, and since the standard deduction if $12,500 (for the 2021 tax year) the child will have not have any taxable income. They can also gift this money back to you, or help pay for groceries.
However, there are some pitfalls. If you are paying them through an S Corp, you must also pay Social Security and Medicare taxes at 15.3%. Therefore, your marginal tax rate needs to be 22% or higher for this to make sense. Conversely, if you pay yourself this income through a shareholder distribution and you are in the 10% tax bracket, you will unnecessarily pay about $636 in general taxes (since payroll taxes are 15.3% and your tax savings is 10%, 5.3% x 12,000 is $636).
You could also pay your child more money since their tax bracket is probably lower than yours.
For regular LLCs, if your child is under 18, the business does not have to pay employment taxes such as Social Security and Medicare. You can also avoid Unemployment taxes until the child turns 21. But for S Corps and C Corps, Social Security and Medicare taxes are paid regardless of age.
However, you can set up a Family Management LLC (there are other branded or marketing terms for this) where the S Corp pays a fee to an LLC which then turns around and processes payroll for the children.
You can read more here-
Your children are going to take your money anyways- might as well make it tax-advantaged.
Your child can contribute to a retirement account and reduce your taxes. Seriously? Seriously!
For example, a 14-year-old can have an IRA or a Roth IRA and contribute 100% of earned wages up the maximum contribution. And since the wages to the child are a direct business expense, this reduces your overall taxable income (lower S Corporation income, lower pass-through income, and lower shareholder taxes).
|IRA Scenario||Roth Scenario|
|Junior’s Earned Income||18,550||Junior’s Earned Income||12,550|
|Junior’s Standard Deduction||12,550||Junior’s Standard Deduction||12,550|
|Junior’s IRA Contribution||6,000||Junior’s Roth IRA Contribution||6,000|
|Taxable Income||0||Taxable Income||0|
|Payroll Taxes @15.3%||2,838||Payroll Taxes @15.3%||1,920|
|Mom/Dad Savings @10%||-983||Mom/Dad Savings @10%||-665|
|Mom/Dad Savings @22%||1,243||Mom/Dad Savings @22%||841|
|Mom/Dad Savings @37%||4,025||Mom/Dad Savings @37%||2,723|
The standard deduction and IRA limits are for the 2021 tax year.
There are several things at play here. First, Junior must actually work and this is the biggest bone of contention with the IRS. So, get that squared away. Second, Junior can still have tax-free income although Mom and Dad are claiming him as a dependent on their individual tax return (Form 1040). This generally preserves certain tax credits.
Another issue to consider is support and claiming Junior as a dependent. If Junior is going to college and Mom and Dad are paying him to work at the family business, in order for Mom and Dad to claim Junior as a dependent they must provide over half of the Junior’s support. This includes the amounts spent to provide food, lodging, clothing, education, medical and dental care, recreation, transportation, and similar necessities.
This creates an interesting conundrum. If Junior makes $30,000 working for the family business, but socks all the money away into savings while Mom and Dad continue to pay over half of the support such as rent, food and education, they can still claim Junior as a dependent.
Yet another caveat to this is education credits. At times Mom and Dad’s income is too high to be eligible for certain education credits. By paying Junior, and having Junior claim the education credit (and he would have to pay for college too, but gifting can assist), the overall household might win.
So, there might be real savings and, in the example above, Junior is saving for retirement.
A Roth IRA contribution is not deductible while an IRA contribution is, which is why the IRA scenario can have a higher salary. There is not a minimum age for an IRA or Roth IRA- you simply need to have earned income to contribute. And Yes, the money is the child’s so when Junior turns 18 and wants to blow it on a new car, it’s gone plus penalty. You can’t fix everyone.
Company-Sponsored Retirement Plan
A company-sponsored plan could be a SIMPLE, SEP or 401k plan. The usual age for these types of plans is 21, but the plan may be created or adopted to be as low as 14 years of age. Therefore, if you hire your 14-year-old and you also have a 19-year-old working for the business, that 19-year old suddenly becomes eligible if your company-sponsored plan allows 14-year-olds. There are hours of service thresholds you could implement as well.
But setting up the 401lk plan correctly allows your child to contribute $19,500 (for the 2021 tax year) to a 401k or the maximum limits on SIMPLE’s and SEP’s which can be significant. In turn the business gets an instant deduction and the kid gets your money, albeit a bit early.
Conceivably, your child could have a $38,050 salary and contribute all kinds of money to his or her 401k plan and IRA.
Here is a table-
|IRA and 401k Plan Scenario|
|Junior’s Earned Income||38,050|
|Junior’s Standard Deduction||12,550|
|Junior’s 401k Contribution||19,500|
|Junior’s IRA Contribution||6,000|
|Payroll Taxes @15.3%||5,822|
|Mom/Dad Savings @10%||-2,017|
|Mom/Dad Savings @22%||2,549|
|Mom/Dad Savings @37%||8,257|
The standard deduction, 401k and IRA limits are for the 2021 tax year.
So the rule is this- if you are covered by a retirement plan at work (what the IRS calls active participation), and you earn less than $66,000 (for the 2021 tax year) adjusted gross income (which Junior does), you can contribute both to a 401k plan and IRA, and get the IRA deduction.
Here is a link about the various options for small business owners to set up retirement-
IRS and State Concerns
You must be mindful of child labor laws, and as far as the IRS is concerned there are some rules too.
First, the child must actually perform work. Some argue that cleaning bathrooms and stuffing envelopes are different since cleaning bathrooms is non-essential to the business operations and therefore not qualifying. The counter argument is that having your child clean bathrooms replaces your third-party janitorial expense. Our advice is to be as legitimate as possible- create a job description, list of expectations, etc. Ensure that the work they do has a business connection.
Also, the pay must be consistent, and the pay must be reasonable relative to what you pay others for similar work. Basically, you need to treat them like any other employee to avoid troubles. Lastly, you need to keep detailed records such as timecards and job descriptions (of course you do!). This must be a perceived as an arms-length relationship.
Many states have labor laws that dictate the age your child can work, even for Mom and Dad. For example, Indiana allows a 14-year-olds to work with a permit. Minors under 14 may work as newspaper carrier, golf caddy, domestic service worker in a private residence (sounds like chores) or farm laborer. Minors under 12 in Indiana can only be farm laborers. Again in Indiana, there is no need for a work permit if the work is outside school hours of 7:30AM to 3:30PM. We bring these examples to light so you understand to check your state or local laws about hiring your kids.
Mom and Dad (your parents)
The concepts above could also be applied to supporting your Mom and Dad. Aside from possibly making them minority owners and providing them with shareholder distributions, there could be some scenarios where a salary could make sense as well. Other sources of income and tax brackets of course all need to be considered.
Jason Watson, CPA, is a Senior Partner of WCG, Inc., a boutique yet progressive tax and
consultation firm located in Colorado and South Dakota serving clients worldwide.
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