Tax Benefits of Hiring Children to Work in the Family Business

Your Guide to State, Local, Federal, Estate + International Taxation

Finding work for young adults that are eligible for employment can be very stressful. In recent years, the economy has created a culture which makes graduating college and taking that next step into the work force one that is not pleasant and incredibly nerve wracking. The family business may be the only place for some kids to find work or to find their first jobs. There is good news for family business owners – employing a child may generate tax benefits regardless of how the family business is organized.

Income shifting – Regardless of how a business is organized, its owners may be able to turn some of their high-taxed income into tax-free or low-taxed income by employing their children. The work done by the children must be legitimate, and the amount that the enterprise pays them must be reasonable for the wages to be deductible. Family taxes are cut even if the child’s earnings exceed his or her standard deduction. That’s because the unsheltered earnings will be taxed to the child beginning at a rate of 10%, instead of being taxed at the parent’s higher rate.

Kiddie tax implications – The kiddie tax applies to the child if he or she does not file a joint return for the tax year and (1) hasn’t reached age 18 before the close of the tax year or, (2) his or her earned income doesn’t exceed one-half of the support and the child is age 18 or is a full time student age 19-23. Thus, employing a child age 18 or a full-time student age 19-23 could cause his or her earned income to exceed more than half of his or her support. This, in turn, could help to avoid the kiddie tax on the child’s unearned income (there is no earned income escape hatch from the kiddie tax for children under age 18).

Even if the kiddie tax applies, it only causes a child’s investment income in excess of $2,100 (for 2015) to be taxed at the parent’s marginal rate. It has no impact, however, on the child’s wages and other earned income, which can be sheltered by the child’s standard deduction.

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 2015, 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 Daniel Blackwell