Summer Is Coming; Put Those Kids to Work! A Tax & Family Win-Win for Small Businesses

‍Five Key Points

1. Skill Development: Hiring your kids helps them develop valuable life and work skills like responsibility, time management, and communication.
2. Tax Deductions: Wages paid to your children can be deductible business expenses, potentially lowering your taxable income and tax liability.
3. Tax-Free Income for Children: Children can earn up to the standard deduction without owing federal income tax, making this a great opportunity for them to save or invest.
4. Strengthening Family Bonds: Working together can foster deeper connections and understanding between parents and children.
5. Consider Legal and Tax Implications: Be aware of child labor laws and ensure proper record-keeping for tax compliance.

Summer Is Coming; And Kids Are Coming with It!

This weekend is the official kick-off of summer! Soon, the long summer break will be here, and if you're a small business owner like many of Purpose Built's clients, you might be considering putting your teen to work. Believe it or not, this can be more than a way to keep them busy—it's a potential tax advantage! Here's what you need to know before you hire your kids this summer.

Why Hire Your Kids?

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Kids aren't yearning for the mines, but hiring your children can be a win-win for both your family and your business. While the idea of bringing your kids into your work might sound daunting, it can actually offer a wealth of benefits:

• Cultivate Valuable Skills: It's not just about stuffing envelopes. Working for your business gives your kids a head start in developing essential life skills like responsibility, time management, communication, and problem-solving. They'll gain a firsthand look at how a business operates, setting them up for future success.
• A Tax-Smart Strategy for Your Business: Believe it or not, hiring your kids can be a shrewd financial move. Their wages are deductible as a business expense, which can lower your taxable income and potentially save you a significant amount in taxes.
• Tax-Free Income for Your Child (Potentially): For 2024, a child can earn up to $14,600 without owing federal income tax, thanks to the standard deduction. This is a great opportunity to teach them financial responsibility and the importance of saving.
• Strengthen Family Bonds: Working together can create a unique bonding experience. You'll get to witness your child's skills and talents firsthand, and they'll gain a deeper understanding of your work and dedication.

What to Watch Out For

While there are many advantages to hiring your kids, there are some pitfalls to be aware of, and you should take proactive steps to address them:

• Child Labor Laws: There are no labor laws at the federal level that limit parents' ability to hire their children in businesses owned 100% by the parents, but state law can really complicate matters. These vary by state and regulate minimum age, hours worked, and allowable tasks.
• Fairness and Professionalism: It's easy to fall into the trap of treating your child differently than your other employees. However, it's important to maintain fairness and professionalism in the workplace. This means having your child fill out an application, sign an employment contract, and adhere to the same workplace policies and procedures as everyone else.
• Meticulous Record-Keeping: Track hours, wages, and any performance reviews (don't add comments about their room's cleanliness). This is essential for tax compliance.
• Paying your child regularly: Establish a regular pay schedule and method of payment (check, direct deposit, etc.), whether it's weekly, bi-weekly, or monthly.
• Withholding income taxes: Even though your child's income is likely below the standard deduction, you may still need to withhold federal income tax. If you withhold taxes, the child can claim a refund for the withheld taxes when they return.
• Filing a W-2: At the end of the year, you must provide your child with a W-2 form that details total earnings and any taxes withheld. They will need this to file her tax return. Don't worry; you don't need costly software to do this; the IRS has a PDF form online that you can complete with the information at the end of the year. 

Tax Savings in Action: A Real-World Example

Meet Sarah, a talented architect who runs a successful consulting business as a solo-entrepreneur designing self-storage units. It's a booming business, working with two builders and bringing in $350,000 annually. Sarah is a sole proprietor, meaning she files a Schedule C with her personal tax return, and she's in the 32% tax bracket (she is married, and her husband also works).

As her business grows, Sarah finds herself struggling to keep up with orders, especially during the summer rush. Her 16-year-old daughter, Emily, is eager to earn some extra spending money (for Lulu & Sephora, of course) and gain valuable experience. Sarah decides to hire Emily to help with packaging, shipping, and managing customer inquiries—all age-appropriate tasks. 

Here's how the tax benefits play out for both Sarah and Emily:

Sarah's Business (Tax Savings Through Deduction)

• Emily's wages: Sarah pays Emily $5,000 over the summer for her work.
• Business deduction: This $5,000 becomes a deductible business expense for Sarah's Etsy shop, lowering her taxable business income to $345,000.
• Tax savings: Because Sarah is in the 32% tax bracket, this deduction translates to a tax savings of $1,600 (32% of $5,000).
• FICA Taxes: Since Emily is under 18 and working for her parent's sole proprietorship, Sarah is not required to pay FICA taxes (Social Security and Medicare) on Emily's wages.
  • It's important to note that:
    • The child will not accrue any Social Security benefits or quarters of coverage towards qualifying for Social Security and Medicare based on these exempt wages.
    • The child's wages are still subject to federal income tax withholding, so the child should receive a W-2 and may need to file a tax return to get a refund of any excess withholding.
    • This FICA exemption does not apply if the business is a corporation, including an S corporation. In that case, the child's wages would be subject to FICA taxes like any other employee.

Emily's Income (Standard Deduction and Roth IRA)

• Standard deduction: For 2024, the standard deduction for a single filer is $14,600. Since Emily's income of $5,000 falls below this threshold, she owes no federal income tax.
• Roth IRA: Emily now has earned income, making her eligible to contribute to a Roth IRA. Sarah, if she wishes to give Emily a headstart on retirement, can contribute up to the amount of Emily's earned income ($5,000) to a Roth IRA on her behalf. This is a fantastic opportunity to kickstart Emily's retirement savings and take advantage of tax-free growth potential.

The Bottom Line

By hiring Emily, Sarah has not only gained a valuable employee but she has also:

• Reduced her tax bill by $1,600
• Helped her daughter gain work experience and save for the future through a Roth IRA

This is a win-win scenario for both Sarah and Emily!

Ready to Hire Your Kids? We Can Help!

Purpose Built Financial Services is here to guide you through the tax implications of hiring your children. We can help you maximize your savings and ensure you're following all the rules. 

Ready to rethink your financial strategy? Contact us today, and let's turn those lessons into actionable plans to build a stable, prosperous future. Your journey to financial freedom starts here, and it's going to be one heck of a ride!

Your financial well-being is too important to leave to chance. Choose wisely.

Important Note: This article provides general information and is not intended as tax advice. Please consult with a tax professional for advice specific to your situation.

We hope this helps you and your family make the most of your summer!

FAQ

Q: Is there an age limit for hiring my children?

A: While federal law doesn't set an age limit for hiring your own children in a family-owned business, state laws may vary. Check your state's regulations for specific age requirements.

Q: What kind of work can my children do?

A: The work should be appropriate for their age and skill level. It should also be legitimate for your business and contribute to its operations.

Q: Do I need to pay my children the same as other employees?

A: Yes, you should pay your children a fair wage for the work they perform. The pay should be comparable to what you would pay other employees for similar tasks.

Q: How do I handle taxes when hiring my children?

A: You can deduct their wages as a business expense. However, you may still need to withhold federal income tax and provide them with a W-2 form at the end of the year.

Q: What are the benefits of contributing to a Roth IRA for my child?

A: By contributing to a Roth IRA, you can help your child start saving for retirement early. The contributions grow tax-free, and qualified withdrawals in retirement are also tax-free.

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About the Author

Sean Lovison, CPA, CFP®, is a flat fee-only financial planner based in Moorestown, New Jersey, serving clients virtually nationwide. After spending 14 years as a corporate chief financial officer (CFO), receiving and designing compensation plans, he decided to help others navigate their plans.

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