Should a small business owner or farmer be paying their children under 18 wages?
Facts:
- Payments for the services of a child under age 18 who works for his or her parent in a trade or business are not subject to social security and Medicare taxes if the trade or business is a sole proprietorship or a partnership in which each partner is a parent of the child. To qualify in a partnership the parents must be the 100% owner collectively of the partnership.
- For 2018, the standard deduction for a taxpayer who can be claimed as a dependent by another taxpayer cannot exceed the greater of (a) $1,050 or (b) $350 plus the dependent’s earned income.
- Your child can pay expenses from this wage that would otherwise not be deductible to you.
- For 2018, your total contributions to all of your traditional and Roth IRAs cannot be more than: $5,500 ($6,500 if you’re age 50 or older), or your taxable compensation for the year, if your compensation was less than this dollar limit.
- $5,500 in a Roth IRA gaining 7% annually would be more than $200,000 in 55 years.
What does this all mean when you put it together? While the child must be able to work in the business, usually even the smallest businesses ask their child to help out in some way or another. The wage must also be reasonable for the work performed. Additionally child labor laws generally don’t apply in family owned business in most states.
Example 1: Donald and Daisy are farmers and they have a son who is 9, his name is Doug helps around the farm in various ways. Don and Daisy pay Doug $4,000 a year for his work around the farm. They also set up Doug with a checking account to help teach money management. Doug gets a debit card and is made responsible for buying his own clothes, paying for his school registration expenses and fees and paying for any entertainment he chooses. Don and Daisy will need to prepare a W-2 for Doug at the end of the year. This will show $4,000 wages and nothing for Social Security or Medicare wages. Doug will pay no taxes. Don and Daisy will save approximately 15% in self employment taxes and another 22% if jointly their taxable income is over $77,400. So they saved $1,480 in taxes with the 2018 tax rates on the $4,000 wage.
Example 2: Mickey and Minnie have a small business partnership that they jointly own 100%. They have a daughter Michelle who is 12 that works in the business helping out with odd jobs. For 2018 they pay Michelle $7,500. Michelle invests $5,500 in a Roth IRA and uses the balance to pay for things she needs for school. Again Michelle pays no federal tax or FICA or Medicare tax. Mickey and Minnie are in the 24% tax bracket so they svae approximatley 15% on self-employment taxes and 24% on income taxes. They save $2,925 in taxes this year. Michelle continues to earn and place $5,500 (or the annual maximum) into her Roth IRA for 5 years. She will have over $1 million in her Roth IRA at age 65 (assuming a 7% growth rate) that she will be able to draw out without paying taxes.
As always, please make an appointment to discuss your specific situation and what you can do.
Todd Green
Green CPA, PLLC Blog 