Now let’s talk about the fifth mistake: missing family employment.
Hiring your children and grandchildren can be a great way to cut taxes on your income by shifting it to someone who pays less.
- Yes, there’s a minimum age. They have to be at least seven years old.
- Their first $6,350 of earned income is taxed at zero. That’s because $6,330 is the standard deduction for a single taxpayer – even if you claim them as your dependent. Their next $9,325 of taxable income is taxed at just 10%. That may be more income than you would have expected you would be able to shift downstream.
- You have to pay them a “reasonable” wage for the service they perform. The Tax Court says a “reasonable wage” is what you’d pay a commercial vendor for the same service, with an adjustment made for the child’s age and experience. So, if your 12-year-old son cuts grass for your rental properties, pay him what a landscaping service might charge. If your 15-year-old helps keep your books, pay him a bit less than a bookkeeping service might charge. Does anyone have a teenager who helps with your web site? What would you pay a commercial designer for that service?
- To audit-proof your return, write out a job description and keep a timesheet.
- Pay by check, so you can document the payment.
- You have to deposit the check into an account in the child’s name. But it doesn’t have to be his pizza-and-Nintendo fund. It can be a Roth IRA for decades of tax-free growth. It can be a Section 529 college savings plan. Or it can be a custodial account that you control until they turn 21. Now, you can’t use money in a custodial account for your obligations of parental support. But private and parochial school aren’t obligations of parental support. Sleepaway summer camp isn’t an obligation of parental support.
Let’s say your teenage daughter wants to spend two weeks at horse camp. You can earn the fee yourself, pay tax on it, and pay for camp with after-tax dollars. Or you can pay her to work in your business, deposit the check in her custodial account, and then, as custodian, stroke the check to the camp. Hiring your daughter effectively lets you deduct her camp as a business expense.
If you hire your child to work in an unincorporated business, you don’t have to withhold for Social Security until they turn 18. So this really is tax-free money. You’ll still have to jump through some paperwork hoops, like issuing a W-2 at the end of the year and reporting their income on their own return if the income is enough to require them to file themselves. But this is painless compared to the tax you’ll waste if you don’t take advantage of this strategy.
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