Entrepreneurs and family-owned businesses are often inundated with job applications from high school and college students seeking part-time employment during their summer breaks. When the competition is fierce and owners are trying to narrow down the applicant pool, many can make the process easier by hiring their own children - and gain the tax benefits of doing so.
Hiring children under age 18 is one of the most overlooked and underutilized tax tools, and understanding the special rules that apply to this scenario may prompt more husband-and-wife owned businesses to urge their kids to work for them during their breaks from school. To begin, the wages of children who are under 18 and working for their parents are exempt from Social Security and Medicare taxes and federal unemployment tax. This also means that parents do not need to worry about worker's compensation premiums, as the child is likely already on their health insurance.
Children can use their standard deduction to shield up to $6,100 in wages from federal income taxes in 2013. This means that when filing season rolls around, it's unlikely he or she will owe any federal taxes on those earnings. More importantly, having more money in their pocket gives kids the chance to set aside money for school or other financial priorities.
Tax benefits and eligibility for owners
While working children benefit from having a little more money flowing their way, parents also benefit from hiring their children, primarily because it enables them to reduce payroll taxes. However, there are certain eligibility rules that owners must meet in order to take advantage of these benefits. For example, the business must be a sole proprietorship or other unincorporated entity that is wholly owned by the child's parents in order to gain access to these tax benefits. Those companies that are considered S- or C-corporations for tax purposes will be required to withhold payroll taxes for all employees, including the owner's children.
In addition, the work performed by an owner's children must be necessary for the business, and the wages paid to them must be reasonable for the type of work performed. This means parents cannot hire their kids to do common family chores and get a tax break for it. In addition, parents may want to either pay their kids handsomely for their work or pay them less than other employees to save money, but this can land them in trouble with the IRS. When hiring kids for a business role, it pays for parents to treat them as they would any other employee. Parents who are uncertain whether they fall within these guidelines can contact their tax preparer for more guidance.
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