Employing children can save taxes. The key notion here is that the first $5,000 of earned income by any aged person is tax free because anyone who earns money gets the a standard deduction up to $5,000 regardless of whether they are claimed as a dependent on another (i.e. parent’s) tax return or not. For example, if a 16 year old earns $5,000 wages from his/her sole proprietor parent, then they will be no income tax paid on the $5,000 by the child, and the parent will get the $5,000 deduction against the sole proprietorship income. This is also true for partnerships or LLC’s or any unincorporated entity.
To go even further, the child could earn $9,000, put $4,000 into an IRA and again, no income tax will be paid by the child. As an additional bonus, for an employed child of a sole proprietor or partnership, under the age of 18, the wages are NOT subject to social security taxes either.
One can get fancier (i.e. higher non taxable income to the child) if a “simple” pension plan is invoked by the business. Up to $15,500 can be earned (and deducted) and the child will not pay ANY income tax.
Warning: In incorporated entities, the wages ARE subject to social security taxes (totaling 15.3%) so the advantages have to be weighed more carefully, but for corporations (like a Sub S) enjoying significant earnings, it can still be worthwhile.
Last caution: the wages have to be for actual work performed and have to reasonable for the nature of the work.
Good luck and here’s hoping it “all adds up” for you.
(If there is any area in accounting or tax that you think needs to be addressed in this newsletter please e-mail Dick at Ginnatycpa@aol.com and if it is of general interest, he will address it in future articles)