Employing family members in your business is one way to reduce the overall family tax bite. Doing so will allow you to shift income and possibly provide them with employment benefits.
Strategy – Employing a Child - By employing a child, the income tax advantages include obtaining a business deduction for a reasonable salary paid to that child and reducing the self-employment income and tax of the parents (business owners) by shifting income to the child. Since the salary paid to a child is considered earned income, it is not subject to the “Kiddie Tax” rules that apply to children through age 18 and full-time students ages 19 through 23. The Kiddie Tax won’t apply at all to the 19- through 23-year-old student if his or her earned income exceeds one-half of total support, another incentive to employ a child in some situations.
The maximum standard deduction available to the child in 2015 is $6,300. Therefore, the standard deduction eliminates all tax on that amount of income if the child is paid $6,300* in compensation. If the business is unincorporated, wages paid to the child under age 18 are not subject to social security taxes. Not only are there significant income tax advantages to employing the child, but the parent-employer may provide him or her with fringe benefits, such as group-term life insurance and qualified pension plan contributions.
The child may also make deductible contributions to an IRA for 2015 of the lesser of earned income or $5,500. By combining the standard deduction and the maximum deductible IRA contribution, a child could earn $11,800 of wages and pay no income tax. If the child balks at contributing his or her hard-earned money to an IRA, the parent might consider giving the child part or all of the IRA contribution as a gift.
*Actually only $5,950 needs to be paid to the child for the child to be able to claim the full $6,300 standard deduction for 2015 because a dependent may claim the sum of their earned income + $350, but no more than $6,300, as the standard deduction.
Strategy – Employing a Spouse - Reasonable wages paid to a spouse entitles the employer-spouse to a business deduction. The wages are subject to FICA taxes, and the spouse may qualify for Social Security benefits to which he or she might not otherwise be entitled. In addition, the spouse may also be eligible to receive coverage under the business’ qualified retirement plan, and the employer-spouse may obtain a business deduction for health insurance premium payments made on behalf of the employed spouse. While maintaining the same family coverage, the business deductions could be increased by providing the spouse with family health insurance coverage as an employee. These wages are subject to income tax. Always remember, when a family member is employed in a family business, wages should equal the work performed, and that the services performed are completely necessary for the business.
If you need more information, contact Dagley & Co., CPA at (202) 417-6640.
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