If you own a business and have children, you may be overlooking a valuable opportunity to reduce income taxes. The basic idea is to shift income to your children and take advantage of their lower tax bracket. In order to implement this strategy, you must first have a business that lends itself to hiring your children. The strategy works best for owners of sole proprietorships, LLC’s or partnerships. It does not work as well for businesses that operate as corporations. Next, the work performed must be directly related to your trade or business and the child must actually perform the work. For example, if you have an office, you might hire your kids to stuff envelopes, scan and shred documents or update files and data. Finally, always consult with your accountant and make sure that you follow all of the IRS rules and regulations.
To give you an idea of the benefits of this strategy, let’s assume mom and dad are in a combined federal and state tax bracket of 37% with taxable income somewhere between $150,000 and $230,000. Let us further assume that we can justify paying your child $8,000 a year. After applying the child’s standard deduction of $6,300, the child would pay taxes totaling $187 on this income. If mom and dad were to keep this income, they would pay taxes of $2,960. This strategy would save them approximately $2,700 per year.
Putting your kids on the payroll not only saves taxes, it serves as a valuable learning experience. Your children will have the opportunity to learn the value of money, responsibility and work ethic and the experience may even help them to determine their future vocation. The child could then put this money in a Roth IRA and have it grow tax free for their retirement. Another option would be to use the money to pay for private school or save for college.
Tax planning is a vital element of any financial plan. We spend a lot of time with our clients implementing strategies to reduce their overall tax obligation. Like the saying goes, it isn’t what you earn that matters, it is what you keep.
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