Here are some ways you may be able to save taxes on your child’s unearned income.
Lower Tax Income
Business owners may shift some of their earnings to their children under the heading of services that they perform. As long as the work they perform is legitimate and the salary they receive is reasonable your business may deduct the wages earned as a business expense. By doing so your business may be able to change over some of your higher-taxed income into a low-taxed or tax free income.
Withholding Income Tax
Federal income taxes will probably need to be withheld on your child’s earnings. Exempt status can be claimed by an employee if they had no tax liability for the previous year and does not expect any for the current year. However exemption from withholding cannot be claimed if:
- income for the employee exceeds $1000 for 2014 and includes more than $350 in unearned income (dividends) for that same year; and
- that employee can be claimed as a dependent on someone else’s return
Social Security Savings
For the purposes of FICA any services performed by a child under the age of 18 while employed by a parent isn’t considered employment. So if your business is not incorporated social security tax dollars can be saved by shifting some of your earnings to your child.
Earnings paid to a child under the age of 21 who is employed by his or her parents are exempt under the FUTA unemployment tax. If a child is employed under a partnership that consists solely of his parents the FICA and FUTA exemptions also apply. If your business is incorporated or is a partnership that includes partners that are not the child’s parents there is no FICA or FUTA exemption for employing your child. However if you are paying your child to perform services that you would have to pay someone else to perform there is no additional cost to your business.
Your business may be able to provide retirement benefits to your child depending on how you qualify employees and what type of plan you have. If you have a Simplified Employee Pension Plan (SEP) contributions can be made up to 25% of your child’s earnings as long as contributions don’t exceed $52000 for 2014. If a child chooses to participate in the SEP it won’t prevent them from making a tax-deductible IRA contribution as long as adjusted gross income is below the level at which deductions for IRA contributions begin to be disallowed. That figure is $60000 for a single individual for the year 2014.
Rules for child employment and the maximum they can earn tax-free change from year to year along with income shifting strategies for your business. Lindemeyer CPA can help you sort through these rules and put the best practices in place for your business. Set up an initial consultation with us today and we will help you put the appropriate tax strategies in place for you and your employees.
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