Guest post by Dawn Cook.
Hey Guys! Well it’s time for another of my (US-law based) Tax Tips.
(I sincerely hope this is available outside the US. Be sure you ask your tax preparer about it.)
Keep in mind that if this tax tip does not apply to you, you may know someone who would benefit and then think very highly of you for sharing it. Also any new tax knowledge is always a good thing as I discussed in my earlier post titled You Must Be Your Own Tax Expert
Here’s a brief video that gives the highlights:
Now aren’t you intrigued by this one. It has multiple advantages for you and your kids–
1. Your child learns responsibility and good work habits
2. You are using leverage even in your own home
3. You save taxes by paying for necessities for your child that you previously could not take as a tax deduction
4. Your child saves taxes with no federal income or payroll taxes if the year’s income does not exceed $5,800 or $110 per week.
(Most states follow federal rules on tax-free income for dependents, but local taxes may apply. Talk to your tax preparer and/or do a little research for yourself.)
This strategy of hiring your kids to do work in your business applies to a sole-proprietor and a single-member limited liability company. In both cases, your business is reported for tax purposes on the Schedule C of your individual tax return rather than filing a tax return for a separate entity. This covers many home-based business owners who have not created a separate entity for their business.
How old do our children have to be to be able to hire them for your business?
They can be as young as seven years old as long as they can handle the business tasks chosen for them. You likely have tasks within your business, like filing, that a seven-year old can do and feel proud and part of the family business.
Now I think I know what you are thinking now and I have an answer.
You may at first think you have to just let your child spend their paycheck any way they choose and you picture a house full of expensive toys, but that is not the case. You can still control how that money is used. Here’s some ideas: college tuition, cars, wedding, graduation trip, school clothes, fees and equipment for sporting events – it must be for the benefit of the child, but everything else is pretty fair game. Just let your child spend a small portion per pay and emphasize that the rest is being used for their benefit in the future. So in addition to using pre-tax money for your child’s allowance, you can also use pre-tax money for other required expenditures that are normally non-deductible personal expenses.
How best to keep account and control of this “excessive” allowance:
You’ll want to open a separate checking or savings account for your working child to deposit his/her payroll checks. Since they are a minor, your bank will require a custodial account and this means only you, the account custodian, will be able to make deposits or withdrawals on that account, maintaining control.
There are Ten fairly easy Requirements to make this strategy above board:
1. Employer Identification Number – must apply for one using Form SS-4-required for all employers (just google Form SS-4 for form & instructions)
2. Signed employment contract – like for any employee – get it in writing and get it signed – good learning experience for child
3. Complete Form I-9 – to document that they are not illegal aliens- required for all employees (yes, I know it seems ridiculous in this situation, but do it anyway- just google “Form I-9”)
4. Complete Form W-4 – just to have on file – there will be no tax withholding required for minors (google “Form W-4”)
5. Type of work must be ordinary & necessary for your business – not what could be called household chores – list the tasks in employment contract
6. Child to complete time sheet or work log – doesn’t have to be formal – just completed on time and legible and show total time worked each day
7. Wage level must be reasonable for the services performed and for the age of the child- ask around or do a little research here
8. Wages must be paid consistently and timely – at least once per month
9. Always use a business check to pay the wages for proper documentation
10. File Form W-2 and W-3 in January of next year – scannable forms, as required, can be ordered at no cost from IRS as you’ll learn when you google “Form W-2” or see link included to file these forms online
The best guide I use specifically related to home-based businesses that covers this tax tip is Home Business Tax Savings Made Easy by Ronald R. Mueller. (Find the book under “Tax Savings Info”, then select “Guide to Tax Breaks”)
Well, there it is, a great tax savings tip, in more ways than one, that I hope you can use and/or share with others to take advantage of. If you already knew and use this technique please tell me about it in your comment. Also if you can now create leverage for your business in your own home by hiring your kids and alleviating some of your stress, I’d love to hear about that too!
Committed to Your Success!
DISCLAIMER: Dawn Cook is not a tax professional or tax attorney. Therefore you must consult with a tax professional before implementing any tax strategy.
See all the posts in this mini-series:
- Taxes – You Must Be Your Own Expert Whether You Like It or Not!
- Tax Tip – How to Use Your Business Expenses to Increase Your W-2 Paycheck
- Tax Tip – How to Save Taxes by Hiring Your Kids
- Tax Tip – How to Make your Trips Qualify as Deductible Business Trips
- Tax Tip – Business Travel – Make It Deductible with Accurate Record-Keeping!
- Tax Tip – More on Deductible Business Travel