Hiring family members can be a sound tax saving strategy. Students seeking summer employment, young adults looking for full-time employment, and college graduates looking to begin their careers sometimes find it difficult to land a job. The family business may be the only place for some family members to find work, even if only temporarily until another opportunity arises. Financially, it makes more sense to keep the family employed rather than hiring strangers, provided of course, the family member is suitable for the job, and not all are.
So rather than helping to support them with your after-tax dollars, you can instead hire family members in your business and pay them with tax-deductible dollars. Of course the employment must be legitimate and the pay commensurate with the hours and the job worked. The following are typical situations encountered when hiring family members.
Employing a Child – A reasonable salary paid to a child reduces the self-employment income and tax of the parents (business owners) by shifting income to the child.
When a child under the age of 19 or a student under the age of 24 is claimed as a dependent of the parents, the child is generally subject to the kiddie tax rules if their investment income is upwards of $2,100. Under these rules, the child’s investment income is taxed at the same rate as the parent’s top marginal rate. However, earned income (income from working) is taxed at the child’s marginal rate, and the earned income is reduced by the lesser of the earned income plus $300 or the regular standard deduction for the year, which is $6,300 for 2016. Assuming that a child has no other income, the child could be paid $6,300 and incur no income tax. If paid more, the next $9,275 earned by the child is taxed at 10%. That can be a sizeable difference in taxes if you are in a 28-40% tax bracket.
Example: You are in the 25% tax bracket and own an unincorporated business. You hire your child (who has no investment income) and pay the child $11,000 for the year. You reduce your income by $10,700, which saves you $2,675 of income tax (25% of $10,700), and your child has a taxable income of $4,700 ($11,000 less the $6,300 standard deduction) on which the tax is $470 (10% of $4,700).
If the business is unincorporated and the wages are paid to a child under age 18, he or she will not be subject to Social Security and Medicare taxes since employment for FICA tax purposes doesn’t include services performed by a child under the age of 18 while employed by a parent. Thus, the child will not be required to pay the employee’s share of the FICA taxes and the business won’t have to pay its half either. In addition, by paying the child, and thus reducing the business’s net income, the parent’s self-employment tax payable on net self-employment income is also reduced.
Retirement Plan Savings – Additional savings are possible if the child is paid more (or works part-time past the summer) and deposits the extra earnings into a traditional IRA. For 2016, the child can make a tax-deductible contribution of up to $5,500 to his or her own IRA. The business also may be able to provide the child with retirement plan benefits, depending on the type of plan it uses and its terms, the child’s age, and the number of hours worked. By combining the standard deduction (6,300) and the maximum deductible IRA contribution ($5,500 for 2016), a child could earn $11,800 of wages and pay no income tax.
Hiring Your Spouse – Reasonable wages paid to a spouse entitles the employer-spouse to a business deduction. The wages are subject to FICA taxes, and the spouse may qualify for Social Security benefits to which he or she might not otherwise be entitled. In addition, the spouse may also be eligible to receive coverage under the business’ qualified retirement plan, further reducing your family’s taxable income.
If you have questions about the information provided here and other possible tax benefits or issues related to hiring family members such as your spouse or child, please give us a call.