Hiring Your Children to Work in Your Business Can Be the Best Tax Move
Once your children are old enough to work in a family business, the tax benefit can be quite significant. In light of tax law changes in 2008, the best strategy is getting earned income to children.
Young Children
Suppose you hire your child at age 14 to help with some basic needs at your business, such as filing or copying, and pay that child a reasonable hourly rate for the services rendered. That child will pay no federal income taxes on this earned income as opposed to you, the parent, who would pay tax on this income at a high rate. Further, if you organized your business as a sole proprietorship or a single member LLC, you do not have to withhold or pay Social Security taxes until the child turns 18. Even if your business is structured differently and you have to pay Social Security taxes, this strategy will still save you income taxes in excess of the cost of the Social Security taxes.
High School Kids
As your child gets older, he or she can work summers and after school and make a higher hourly rate. In 2008, if you can justify their salary as reasonable, you can pay the child up to $5,450 and the child still pays no federal income taxes. In fact, it can get even better, because the earned income permits the child to contribute up to $5,000 to a traditional deductible IRA. Therefore, the child could receive up to $10,450 in compensation and still pay no federal income tax.
Roth IRAs: The Best Choice for Children of All Ages
The idea behind a Roth IRA account is that the contribution you make to such an account is with after-tax dollars but the income earned over the years will generally grow tax-free. The earlier you fund a Roth IRA, the bigger the tax savings. The key to making Roth IRAs is that you must have earned income. So, hiring children early and establishing a Roth for them allows that income to grow tax-free generally for the rest of their lives. In 2008, if a child has earned income up to $5,000, they can contribute all of it into a Roth account. Further, any contribution, but not the income, can be withdrawn at any time without tax implications. So, if the child needs the money for college or later in life for a house, those contributions can be withdrawn tax-free. Parents can set up a custodial Roth IRA and control these investments until the child reaches the age of majority.
College-Age Children: Maximize Your College Tax Credits
If you, the parent, are in a high tax bracket, you generally do not qualify for a $2,000 lifetime learning credit for your college-age child. Under a loophole in this tax law, if you waive the dependent’s deduction for this child, the child can qualify for their own $2,000 credit. What this means is that a child can earn up to $21,458 in 2008. The child will owe $2,000 in taxes but can use the $2,000 credit. In other words, the child pays no taxes on this income.
Conclusion: Before you implement any of these strategies, there are other significant issues to consider beyond the scope of this alert. Please call us to discuss your particular situation and how you can best benefit under the tax law.


New Crackdown on Employment Taxes

The IRS announced that it has teamed up with 29 states (with others joining soon) to crack down on employment tax violations. The primary focus is on which workers should be treated as independent contractors and which should be classified as employees. These agreements are part of the IRS’s Questionable Employment Tax Practice (QETP) initiative, which will provide a centralized, uniform means for the IRS and state employment affairs to exchange data, thereby leveraging resources and encouraging businesses to comply with federal and state employment tax requirements.

Caution: It is a common misconception that someone working part-time or earning less than $600 per year should be classified as an independent contractor. In fact, part-time status and the number of hours worked are generally not factors that determine whether a worker is an employee or independent contractor. Determining the correct result can be very tricky. Usually the outcome depends on control. If the business has control over its workers to such an extent that it can control what will be done and how it will be done, that generally means that the workers are employees, and payroll taxes and worker’s compensation must be paid by the employer.

Warning: If a company is treating a person as an independent contractor, but that person believes they are an employee, that worker can file Form 8919, Uncollected Social Security and Medicare Tax on Wages, with the IRS. In this case, the worker only has to pay the employee’s share of employment taxes; however, if the company is treating this worker’s payroll improperly, it is responsible for the employer’s share of the taxes, plus penalty. Employers can also get in trouble if an independent contractor files for unemployment, telling the state that he or she believes they are an employee. In that case, a state could share such information with the IRS, indicating that the contractor might, in fact, be an employee.

Note: Employers think they save money by treating people as independent contractors, but beware. If an independent contractor gets hurt on the job, he or she is not covered by worker’s compensation. The company could be on the hook for a major legal liability. The general consensus is that treating someone as an employee is generally safer, for a whole host of reasons.

Determining worker status and filing and paying employment taxes can be a complex process. If you are a business owner who needs assistance, you should immediately call to discuss your particular situation.

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