By Nationally-Known Tax-Deduction Expert Dr. Ron Mueller
Small and home-based business (HBB) owners can easily qualify for some amazing special tax deductions. One of the least understood – yet one of the biggest of them all – involves hiring your minor children to work for you in your home-based business.
DON’T give your kids an “Allowance.”
THAT teaches them dependence on receiving “HANDOUTS” for doing nothing.
INSTEAD pay them a fair wage for contributing value to the parent’s home-based business.”
THAT teaches them “financial empowerment”
A skill that will benefit from for a lifetime.
Big SIDE-BENEFIT is that you can get a huge tax deduction for doing it.
Most people believe a child needs to be at least 16 to get a job, and at least 18 yo for some specific jobs. These are called Child Labor Laws, laws passed to ensure that younger children are not being exploited and not working in an unsafe environment. However…
The Courts have ruled that a child working for his or her own parent in his or her own home, is presumed to be in a safe working environment.
Therefore, for your kids working for you in your home, Child Labor Laws do not apply.
In fact, in a precedent-setting Federal Tax Court ruling, the judge said: “Any child over the age of SIX can surely perform viable work in parent’s home-based” (sole proprietorship or LLC) business. [Eller v. Commissioner, 77 T. C. 934 (1981)]
Don’t Give Your Kids an Allowance! HIRE THEM!
It is quite common in many cultures to see children actively involved in a family business. Even young children can perform valuable services that are “reasonable and customary” for most any type of business. Many entrepreneurs, however, miss out on some major tax savings available for hiring their children to work in their home-business—simply because they don’t know the rules and benefits you are about to discover right now. [Tax Court Memo 1992-50 in Jordan v Commissioner]
The wage you pay them is TAX-DEDUCTIBLE TO YOU, as the employer, and the wage income received by the minor child is TAX-FREE to your CHILD. [Reg. Sec 1.162-7(a)]
Isn’t that about as good as it could get?
(a) You pay your kids/employees with tax-free money, and
(b) they receive the wages as tax-free income.
NO taxes are EVER paid on ANY of those monies!
How MUCH Can They Earn TAX-FREE?
The tax-free limit is “equal to the Standard Deduction,” which changes each year. Well guess what? As of Jan. 1, 2018, the Standard Deduction has doubled to $12,000 for individuals. Therefore, the federal tax-free limit on earned income for dependent children is now a whopping $12,000 per child! That means up to $1,000 per month! Tax free! [Rev. Proc. 95-53 and IRC Section 63(h)(2)]]
If they earn more than the $12,000 tax-free amount, they’ll simply pay the minimum tax rate (10% for 2018) on any amounts over and above $12,000.
Any restrictions on what kind of work could they do?
Another Tax Court ruling that said the services performed “should not be those that would reasonably be called ‘household chores’ because they are part of parental training and discipline rather than services rendered by an employee to an employer.” [Denman v. Commissioner, 48 TC 439] [Hable v. Commissioner, 48 TCM 1079]
Another court case further clarifies: “Ensure that the duties are ‘ordinary’ for the operation of the business and that, if these services had not been done by the employed child, a third party would have to be hired.” [Eller v. Commissioner, 77 TC 934]
What kind of work could they perform?
Depending on their age, they might transcribe your voicemail messages; enter the day’s income and expenses into a tax deduction record keeping system; type-up and print-out your appointment schedule for the next day; perform online research; prepare Power Point slides; organize your travel itinerary, etc., etc. Use your imagination.
How about payroll taxes? If the employee/s (a) is/are your own children, (b) are under 18 years old, and (c) qualify as Dependents on your tax return, they are exempt from Payroll taxes, Social Security and Medicare taxes on wages paid to those children.
If you have children between 18 and 24, they may also qualify for the $12,000 exclusion in 2018 if they are “full-time students” (at least 5 months during the tax year), although they will be subject to payroll tax withholding. [IRC § 3121(b)(3)(A) and § 3306(c)(5) [TCR 48 TC 439, 450 (196) in Denman v. Commissioner.]
How about the wage level I pay them? The amount of wages you pay each child must be (a) reasonable within your local area, (b) common for your type of business, (c) appropriate for the age of the child and (d) commensurate with type of work being performed. [Rev. Ruling 73-393]
How do you establish what is “reasonable?” One way would be to get an outside service or third party, to give you a written estimate for the work to be performed. Put a copy of the quote in your tax file, and then pay your child/employee the equivalent of that amount, or a little less. [Rev. Rul. 72-23, 1972-1 C.B.43] Or you could determine how much a reasonable person might pay a small business, a freelancer or an independent contractor for such services, and pay a similar (or slightly lower) wage to your child/employee. [IRS Regulation § 1.162-7(a)]
Pay Attention Here, because you are about to discover how tax-free dollars could pay for . .
The car your high-schooler wants
Designer-label clothes the kids “require”
Movie and Concert tickets
A High School graduation trip
College tuition, books, and supplies
Your daughter’s expensive wedding
. . . ALL paid for with TAX-FREE Dollars!
Did you ever, in your wildest dreams, anticipate that you would be able to pay for school supplies and tennis shoes, or pay for cars, trips and weddings, out of non-taxed dollars?
It’s true! It’s real! And it’s 100% legal!
Here’s how . . .
Let’s say you employ your child to perform specific ongoing work in your home-based business, and agree to pay him or her $75 per week for those services. Assuming they have turned in their “work logs” on payday, you would pay them their weekly wages—always with a business check. (Because that’s how businesses pay their employees, right?)
What’s a 10-year-old going to do with a check? You’ll want to open a separate checking, savings or investment “Custodial Account” with each child to deposit their payroll checks. With a “custodial account,” it’s your child’s account, but YOU are the CUSTODIAN of the funds since minors cannot legally conduct banking transactions.
That means that only you (the account ‘custodian’) will be authorized to make deposits or withdrawals on that account, since the child is under-age. For record keeping purposes, you should deposit the full amount of each of their paychecks into that account, even if you then withdraw part of it for them to use.
You may wish to bring your child with you to the bank to make the deposits and make any withdrawals. Why? If they are young, they may learn for the first time that you must put money IN the bank BEFORE can take money OUT of the bank. How many kids have grown up thinking that adults can get money anytime they want, if they just insert a plastic card into the slot of an ATM machine?
Here is Where It Gets Really, REALLY Interesting. . .
The law requires you to pay them the wages they earned, of course, in order for you to be able to deduct the wage as a business expense. HOWEVER, there is very little restriction on how you (as his/her account ‘custodian’) can use the money after it has been paid – as long as it is used to directly benefit the child. [Revenue Ruling 73-393]
How could that wage money be used, and by whom?
These funds earned by the child, could be used to help pay for private school tuition, after school sports equipment, music lessons or instruments, school trips, educational summer camps—even sox and underwear! They will learn an important “life lesson” by earning them rather than mom and dad gifting it to them.
Or you could leave all (or most) of the wages in the account, earning compound interest. Eventually your child could be paying for their college, their wedding, a graduation trip, car, etc. with tax-free money! In the meantime, they are learning the powerful concept of compound interest. They are learning how to deal with (and accept) “delayed gratification.” They can be learning about budgeting; about balancing a checkbook; about paying with cash instead of plastic.
There are also other practical “learning-lessons” built into this strategy that are at least as important as the tax benefits. By working for you, the child learns that, as an employee, there are only two ways to earn more money, and both of them require permission of the employer.
One way, as an hourly employee, is to work more hours. The lesson: If the boss agrees, you can earn more money—but only if you work more hours!
The only other way to earn more money as an employee, is to perform work that has a higher perceived value than what you’re doing now. The lesson: No employee is ever paid what he/she is worth, only what the job is worth—and the boss decides what the job is worth.
Meanwhile, they also learn (by observation) that self-employed people (like mom and dad) do not have those restrictions. If they want to get paid more, they can make it happen for themselves, AND they can do it without needing to get some boss’ agreement.
Your child will also begin learning the value of money, and the trade-offs between spending and saving money, and the difference between instant-gratification v. delayed-gratification.
Here’s my FAVORITE: How about learning the value of investing.
If your child contributed the maximum amount of $5,000 per year into a Roth IRA for ONLY FIVE YEARS, say from ages 13 through 18, and if that money earned an average of 10% APR, by the time they reach retirement age, they’d have MORE THAN $2-MILLION in their retirement account. They’d pay taxes on the money they put IN to a Roth, but only at the 10% minimum tax rate, but they will pay NO TAXES when they WITHDRAW it. Is that an important lesson they could learn?
HERE ARE THE MOST IMPORTANT WORDS IN THIS ARTICLE:
If you allow your child(ren) to work for you in your home-based business, the years they are growing up, could also be the years they become financially literate – for life.
And they are not getting these lessons from a textbook and a teacher, while sitting in neatly-lined-up, forward-facing desks in a sterile classroom, wondering to themselves, “will I ever use this stuff in real-life?”
They will already have that answer within them, because THEIR learning will come from their own REAL LIFE!
Let me leave you with this final thought, if I may:
Hiring your kids to work in your home-based business will give YOU huge TAX benefits. Hiring your kids to work in your home-based business will give YOUR KIDS huge LIFE benefits.
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