Tax-Savings Strategy: Hiring Your Children and Grandchildren
Let’s talk about the benefits (and some of the pitfalls) of hiring your children and grandchildren to work for your small business.
Hiring children who are under 18
It’s important to follow the right procedures when hiring your kids who are under 18, or this strategy could backfire on you. Here are the pertinent facts and rules to follow when putting your minor children to work in the business.
First, you don’t have to withhold any income taxes or payroll taxes. This also applies to workers’ comp as well as state and federal unemployment insurance. The reasoning is that the government and insurance carriers assume your children won’t sue you if they’re hurt on the job -- at least we hope not. Your children are also probably on your health insurance plan; you’ll end up paying the bill one way or another. Moreover, they’re unlikely to file for unemployment insurance since they’re dependents and you’re providing for their care. Again, this is only for children under 18. Still, I recommend you review the laws in your jurisdiction to ensure you’re operating legally regarding workers’ comp and other payroll taxes as well as work permits and other regulations.
Second, all of us, including our children, don’t pay taxes on the first $12,200 they earn in 2019. It’s the standard deduction which is adjusted for inflation each year. Interestingly, you can still claim your children as dependents on your tax return and take the child tax credit if you qualify. However, they don’t pay taxes on their earned income up to the standard deduction. Stated another way, your children get their own “standard deduction” for their earned income even if they’re a dependent of yours on your tax return.
Therefore, when you pay your children for services they perform in your business, you can generate an expense for your income taxes by pushing income to your children. Of course, I’m not advocating you pay your children as a “sham” operation. They must be legitimately involved in the business; you’ll want to keep records of their time worked as well as pay them a reasonable wage. This could include having a clear job title and description for the child and keeping track of their tasks.
The IRS allows any sole prop or partnership (LLC) that is wholly owned by a child’s parents to pay wages to children under 18 without having to withhold payroll taxes.
However, if you have an S or C corp, be careful of this strategy. You don’t receive the benefit of avoiding FICA when paying your children unless you pay them through a sole prop or an LLC owned solely by mom and dad. Bottom line: Don’t pay your children out of a corporation, or you have to withhold payroll taxes.
Thus, we recommend you pay children out of a family management company, structured as a sole prop or LLC with independent income and operations and paid a management fee from the corporation.
Hiring children 18 and older
If you’re hiring children 18 or older, you have the option of treating them as subcontractors or as employees. If you pay them as a subcontractor, you simply issue them a 1099 in January. They file a small-business Schedule C, get to take small-business tax deductions, take a standard deduction of $12,200 in 2019 (adjusted for inflation each year), and will probably be in a lower tax bracket than you. If done properly, the savings you get as a family can be phenomenal. I love to see older children serving on the board of directors in a corporation or board of advisors in an LLC, providing advisory services, marketing support, research, consulting, etc.
However, if your adult child works in your business alongside your other employees and looks like and acts like an employee, then you need to treat them as an employee. Thus, you’ll have to withhold FICA and other typical payroll fees. Again, with overall family tax planning, there’s nothing wrong with this and a little tax strategy with your kids can go a long way. If you plan on helping them financially, anyway, at least make them earn it.
Don’t think I forgot about you, grandparents! Certainly, we also want to teach our grandkids the importance of hard work and entrepreneurship. Again, why not try to integrate them into the business with legitimate services you need and were going to outsource or do yourself anyway?
The tax strategy for paying grandchildren, however, isn’t by direct payment but to 1099 your children and the support company they establish to supervise and hire their children, i.e., your grandkids. This way, they can pay the kids under the “children under 18” strategy and save you from giving the grandkids a W-2 or 1099. Your children won’t pay taxes either because on their Schedule C reporting the support company operations, they’ll claim the income you 1099’d them and deduct the payments to your grandkids, thus zeroing out the income of their business supporting your business.