Q: I own my own service business. I have certain financial responsibilities to my family and my parents. I've been told that there are some tax laws that would allow me to reduce my taxes, yet still provide financial support to my family. Is that true, and, if so, how can I do that? Also, I heard that by hiring independent contractors I can save considerable payroll taxes, as compared to hiring regular employees. Is this a valid strategy?

A: Tax law allows you to reduce your family's overall income tax liability (business and personal) by hiring your family to perform work in your business.

As a small-business owner, you have an opportunity to hire your spouse, your children and even your parents as a way of minimizing your family's tax burden. By shifting taxable business income to another family member, you can move dollars from higher tax rates to lower tax rates-creating real tax savings for you and your business.

Under age 18 (and at least 7-the IRS has approved that age for employing your children), your children are exempt from Social Security and Unemployment Taxes through an unincorporated business.

Pay your children when they perform legitimate work in your business. If you planned on giving them money anyway, this is a fantastic way to give them wages that are tax-deductible to your business, tax-free to them (up to the $4,750 standard deduction), and you still get to claim your children as dependents on your personal income tax return. For wages in excess of $4,750, their beginning tax rate is only 10 percent.

Note: Pay your children contemporaneously (not just at year-end) and in the same manner as other employees-on a regular basis by check.

You can pay your parents wages (for legitimate work) with tax-deductible dollars from your business. These tax-deductible (before-tax) dollars replace the after-tax dollars that you otherwise would have given them. Because you are paying them with your business's before-tax (tax-deductible) dollars, there are more of these dollars to give them than you otherwise would have had available for them; this is because after-tax dollars would be less than before-tax dollars by the amount of tax paid.

When you use independent contractors in your business, document their independent contractor status carefully. If you hire and pay independent contractors when they are actually working as employees, your business may be liable for payroll taxes on these individuals.

The IRS uses specific criteria to determine if an individual is entitled to be paid as an independent contractor. When you pay independent contractors, you save your business the cost of payroll taxes, as they are not entitled to those benefits. Compare that to wage-earning employees, who are entitled to payroll tax benefits.

You can hire an individual as an independent contractor if he or she meets the IRS's criteria. The IRS says these factors tend to show a person is an independent contractor:

  • The worker hires, supervises and pays his or her own employees.
  • The worker is free to work when and for whom he or she wishes.
  • The work is done on the worker's premises.
  • The worker is paid by the job or on a straight commission basis.
  • The worker is at risk of profit or loss.
  • The worker does work for several businesses at one time.
  • The worker's services are available to the general public.
  • The worker can't be fired, except for breach of contract.

Note: You are required to prepare a 1099 (instead of a W-2) if you paid an independent contractor $600 or more for his or her services during any single tax year.

Note: The information in this column is provided by the author, not Entrepreneur.com. All answers are general in nature, not legal advice and not warranted or guaranteed. Readers are cautioned not to rely on this information. Because laws change over time and in different jurisdictions, it is imperative that you consult an attorney in your area regarding legal matters and an accountant regarding tax matters.


David Meier is the founder and COO of Business Development Coaching, a company that provides small-business owners with ongoing business coaching.