Consider adding your teenage children onto your company payroll.

If you are self-employed and have children that are old enough to work, consider adding them onto your company payroll.  There are several tax benefits and opportunities for income shifting within the family when children become employees of your small business.

  • Under the recently passed Tax Cuts and Job Act (TCJA) of 2017 the new standard deduction has been increased to $12,200 for individual filers in 2019. This increase allows employers to pay their children $12,200 in wages free of income taxes.  And the payment of wages to your children from your business is an allowed tax deduction reducing the business owner’s taxable income and resulting taxes.
  • The wages paid to your child can be contributed to a Roth IRA. Wages are considered earned income for IRA contribution qualification purposes.  A taxpayer can contribute annually to a Roth IRA subject to earned income limits.  For 2019, the maximum IRA contribution is the lesser of the child’s earned income or $6,000.  Starting retirement planning at such a young age will help introduce your child to good financial habits.   Additionally, the invested retirement funds have the potential to grow immensely over your child’s lifetime.
  • The wages paid by the company to their children can be used to pay education expenses. Thus, the small business owner would indirectly be getting a tax deduction for payments to their children’s colleges and private schools.
  • You can include your children in the company retirement plan, allowing additional retirement funding for the family while reducing your company’s taxable net income and resulting income tax.
  • If your business is set up as a Schedule C (sole proprietor or single-member LLC), the wages paid to your children that are under age 18 are not subject to social security or Medicare taxes. This payroll tax savings for the family can be as high as 15.3% of the wages paid to your children, in addition to the income taxes saved.  Additionally, if your child is under age 21, your child is exempt from federal and state unemployment taxes typically paid by the company.

A few considerations when paying your children.  Document the work being performed by your children and maintain a log of the hours worked by your children each pay period.  Be sure the hourly rate paid to your children is fair and not overly excessive for the work they are hired to do.  And pay you children at the same time that you pay other employees and on the same pay cycle.  Plus, you will need to issue a W-2 to each employed child as well. If your business is ever audited by the IRS, the IRS will want to validate that the work performed and hours worked by your children for the period under audit are accurate and that the payments to your children truly qualify as a valid business expense.