Do You Hire Your Children to Lower Your Tax Liabilities?
If you have not been taking advantage of the tax benefit of hiring your kids because you want them to focus on their school activities, why not changing your focus now to get a huge tax saving and get them an early start? Your children could substitute for your assistant, especially during this pandemic while you are running business at home. You could design a job description for your children. The benefit is great: building work ethic early, saving in tax liability, and much more.
Hiring your children to work in your business has always been a great tax planning strategy, shifting income to your children. The changes in the tax laws make it even better because of the doubling of the standard deduction. Your children income could be tax free or they would pay the tax at a lower tax bracket.
Be mindful that the IRS is looking for taxpayers who did not follow the rules:
Rule 1: Your child must be a real employee. The work must be ordinary and necessary for your business, and the pay must be for services actually performed. The service must be appropriate for your business. Any real work for your business can qualify. The IRS has accepted that a seven-year-old child may be an employee, but that might not be the case for a younger child. It also depends on the State employment laws and the type of work or service.
Rule 2: The compensation must be reasonable. It is advantageous for tax savings purposes to pay your child as much as possible. However, it must be in line with the standard pay in the industry for comparable work in the geographic area.
Rule 3: You must comply with all of the legal requirements for employers. You should complete the same procedures that are required when you hire a person not related to you.
Andrew is the sole shareholder of a S Corporation. For the past 5 years, he was not on the payroll of his S Corporation. Consequently, he missed some huge tax deductions. Last year after a tax consultation, he decided that he was going to run his business differently. He did the followings:
1. He determined a reasonable salary for himself and his 19 years old son. Yes, he hired his son, who is attending college.
2. He agreed to sign a contract for payroll services.
3. He signed a contract for accounting services and committed to a monthly meeting review.
For 2019 tax year, Andrew benefited a huge tax saving. He had over $10,000 tax free, the salary he paid to his son, as a business expense. The son received a tax refund of about $800.00. The amount of taxes withheld from his paychecks. Andrew had his own salary also deducted as business payroll expenses. Consequently, the business net income is lower which translated to less net business income on his K-1 form. In addition, he benefited another deduction from QBI (Qualified Business Income).
Do you know that you could reduce your tax liability by proper tax planning strategy as individual or business owner?
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