If you are a Sole Proprietor, there’s a particular advantage you have over firms that have incorporated. You can employ your own kids, so long as they’re under eighteen, and pay no federal payroll tax. And interestingly , they don’t pay any income taxes on the moneys they get.
As an example, if you employ your under-18 years-of-age child to work in your sole proprietorship and pay him or her a reasonable amount of $10,700 (based on 2010 tax figures) for services rendered, you get the write-off and the minor files a return showing no income tax liability. How is that done?
You have to file a few payroll tax forms, such as a quarterly Form 941, a yearly IRS Form 940, and W-2 for the child. Nonetheless, you pay zero payroll taxes if you’re a proprietor and paying the salary of your under eighteen child. Also, there aren’t any workmen’s compensation insurance or state unemployment costs. You’ll have to note on these payroll tax returns you’re paying your minor child’s wages. The minor must file an annual individual tax return showing the total wages on line 7 of the 1040. If the child takes out an Individual Retirement Account for $5,000, that leaves $5,700 in adjusted gross income. On page two of the 1040, the minor can take the standard deduction of $5,700 which leaves zero as taxable income. Also, the child can still be claimed by yourself as a dependent on your income taxes.
Remember, the check needs to be written to the minor and deposited into his or her checking account. However. a minor child can’t get an account without the joint signature of a parent. Therefore, you have control of account so that the minor doesn’t waste the money. The minor can gift the money back to the parent, pay expenses or at the very least pay for their own education, but be cautious with this. You have to be reasonable. The child’s duties have to be valid, documented and consistent with your payroll policies.
The beauty of this tax move is that you wrote off $10,700 from your proprietorship and saved 43.3% (calculated using a 28% tax bracket and 15.3 percent self employment taxes) in taxes and your kid paid 0 on his tax return. The net is about $4,600 in tax savings.
If you don’t have a proprietorship, start one and then you will be in a position to take advantage of these tax advantages. See your tax adviser for more.