Post On: April 29, 2019
Posted In: General
Your kids looking for a bigger “allowance;” you looking for a bigger business tax break? Keep reading…
Paying children in a family business can be beneficial to both parents and children. Parents can deduct wages paid to children from their taxable income. This can impact their tax bill considerably, depending on how many children are working and whether the parents’ income tax bracket changes after deducting the children’s compensation. There is also the benefit of avoiding payroll taxes, if the family business is unincorporated and the wages are not subject to FICA and FUTA taxes.
If the business is taxed as an S corporation, however, the solution is not quite as simple. In order to gain the same benefits, the family can establish a family management company (FMC) that is “operated” by the children and taxed as a sole proprietorship or partnership. Parents simply set up a bank account associated with the FMC to pay a management fee from the S corporation. It may sound complex, but the benefits are worth taking the time to understand.
What’s more, since the individual standard deduction has increased from 6,300 to 12,200, the tax savings potential has virtually doubled for a family owned business with at least one child. The children can take advantage of the standard deduction in the year the wages are earned, which means that only wages in excess of 12,200 per child are taxable.
Going a step further, the wages paid to the child can then be invested in a Roth or Traditional IRA, each with its own retirement and savings benefits. A Traditional IRA offers a tax benefit of up to 6,000 in deductible wages for the child on top of the standard deduction (12,200 + 6,000 = 18,200 total per child). Conversely, with principal and earnings that grow tax free, Roth IRAs do not qualify for a deduction, but still provide an excellent savings tool for children. Both Roth and Traditional IRAs can be used for certain expenses before retirement with no penalty, such as college education and purchasing a home.
When deciding to employ a child with tax benefits in mind, it is important to remember children need to be treated similarly to any other employee within the business. “Similar treatment” includes things like recordkeeping, pay schedules, and business-related responsibilities. Wages paid to children must also never be used to buy things that could fall under the basic needs of the child, such as food, shelter, and clothing. This ensures adherence with the IRS regulations and reduces the likelihood that a tax deduction is rejected at the end of the year.
It’s important to talk through different options before launching on any of the strategies above. At Ambassador Advisors, we are here to guide you through the wealth planning process and are continually looking for the most efficient tax strategies for individuals and families.
Any opinions expressed in this forum are not the opinion or view of American Portfolios Financial Services, Inc. (APFS) or American Portfolios Advisors, Inc.(APA) and have not been reviewed by the firm for completeness or accuracy. These opinions are subject to change at any time without notice. Any comments or postings are provided for informational purposes only and do not constitute an offer or a recommendation to buy or sell securities or other financial instruments. Readers should conduct their own review and exercise judgment prior to investing. Investments are not guaranteed, involve risk and may result in a loss of principal. Past performance does not guarantee future results. Investments are not suitable for all types of investors. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purposes of avoiding penalties that may be imposed by law. Each tax payer should seek tax, legal or accounting advice from a tax professional based on his/her individual circumstances.