With school back in session, some students may be looking for part time jobs to keep up with the cash flow they received from their summer jobs. Many of these students may be claimed as dependents on their parents’ tax return. For parents, claiming a child dependent can lead to tax savings. Parents are potentially afforded a $4,050 exemption per child. In addition, an exemption on a state tax return may also be available.
According to the IRS, to qualify as a child dependent on the parents’ tax return, the child must:
- Be younger than 19 years old, or a full-time student younger than 24 years old.
- Not provide more than half of their own support.
- Live in the same place of abode as his or her parents (being away at school counts as the same abode).
If you’re a parent who owns a business, you should consider:
- Paying a child dependent since a parent/employer is able to deduct the wages paid to the child as a business expense,
- And your child earns a fair income that may be free of income tax.
A working child dependent can receive more financial benefits than just living at home:
- A child’s earnings of up to $6,350 are exempt from income tax due to the standard deduction.
- By contributing $5,500 to a traditional IRA, your child can receive tax-free income of $11,850 ($6,350 + $5,500).
Here is a simple, five-step outline to help visualize your unique tax advantages as a parent employer:
- Pay your child $11,850 in wages – this must be fair based on the services your child provided.
- As the employer, you get to deduct the total amount as a business expense.
- Help your child put $5,500 of their wages into an IRA account.
- Your child can subtract the $5,500 IRA deduction and $6,350 standard deduction and owe no tax.
- All of that money is deductible to you, and is tax-free income for your child.
Another alternative is to gift your child the additional $5,500 to contribute to an IRA. Your child can then use the remainder of his/her wages to cover the cost of nightly entertainment!
As with any claims you make on your tax return, it is important to document anything pertinent to your situation. For example, always record your child employee on your business’s payroll to avoid any doubt by the IRS that your dependent(s) have been legitimately employed.