Maximizing Tax Benefits: Hiring Your Children as Employees

As we enter the second half of 2024, I’d like to share a strategy that could potentially yield significant tax savings for clients who operate a family-owned business: Hiring your children as employees. As with any tax advice, this serves as a guideline and should be discussed with your tax professional before making any decisions.

Employing your children, provided they are of appropriate age and can perform legitimate work for your business, can offer several financial advantages:

1. Tax Deductions: By employing your children, you can deduct their wages as a business expense, thereby reducing your taxable income. This can lead to lower tax liabilities for you and your business at the end of the year.
2. Income Shifting: You can shift income from your higher tax bracket to your children's lower tax brackets. This is particularly advantageous if your children have little to no other income. The standard deduction for single filers in 2024 is projected to be around $13,950. This means, your children can earn up to this amount in taxable income before they would owe federal income tax.
3. Retirement Contributions: Wages paid to your children can also be used to fund retirement savings accounts such as Roth IRAs (Individual Retirement Accounts). This money grows tax-free at is withdrawn tax free at retirement. 

An example: Suppose you have 3 children between the ages of 14-20. Your business can choose to hire all three children and pay each child $13,500 for administrative work performed throughout the year. If your business is a pass-through entity, your individual income would be reduced by $40,500. Given the approximate 40% tax rate (Fed and State), you would personally save $16,200 in taxes. If this is the only income each child receives from all sources in the year, no taxes would be owed for the children as the $13,500 is below the standard deduction. In addition to your family saving $16,200 in taxes, each child can place $7,000 into a Roth IRA and invest, thereby growing these monies in their respective retirement account tax-free forever! Furthermore, the excess $6,500 income in this example can be placed in each child’s 529 program, obtaining further tax advantages for education accounts.     

It's important to note that the IRS requires that the wages paid to your children be reasonable for the work performed and that all employment tax requirements are met. Keeping accurate records of their work hours and duties performed is crucial to substantiating these deductions.