If you run your own small business, hiring your child for the summer may be a win-win situation. More of your money will be kept out of the IRS’s hands while your child earns some extra money and hopefully gains some valuable workplace skills along the way. Keep reading below to discover some benefits to employing your child.
As long as the pay is reasonable in relation to the time your child spends working and the tasks they perform, you can deduct the wages paid to them as a business expense. But remember that you have to play by the rules. The work must be legit and in connection with your trade or business.
Tax-Free Income for Your Child
While wages do in fact represent taxable income, in 2013, a dependent can earn up to $6,100 and pay no federal income taxes due to the standard deduction. Additionally, if their earnings are in excess of the $6,100 threshold, the first $8,925 is only taxed at 10% for single taxpayers in 2013. With top individual rates now reaching 39.6% your marginal rate is probably higher than your child’s, therefore the deduction for your child’s wages is likely worth much more than the amount of tax your child may owe.
The wage deduction could also save you some self-employment tax. And if your child is younger than 18 and your business is not incorporated, your child’s wages generally will not be subject to Social Security and Medicare (FICA) taxes.
Kick Start on Saving
While your child is likely prone to spend summertime wages on clothing, movies and music, opening an individual retirement account (IRA) could be a great way for him or her to start saving and will let the power of tax-deferred compounding do its thing. As much as $5,000 of their earnings could be contributed in 2013 to the account. Contributions to a traditional IRA could potentially be tax deductible to your child, so there should be no current tax on that amount. We however, typically recommend opening a ROTH IRA. Although ROTH contributions are not deductible, this type of account can provide your child with years of tax-free earnings growth and distributions in retirement will not be taxable to them. For more information on opening a ROTH for your child, see Danny Osborne’s article, “ Retirement Planning… For Your Children .”