Paying wages/salary to minor children.

Many business owners are curious and interested to know about different ways to save money on taxes.  This article will introduce you to a legal way of reducing businesses or corporate taxable income by paying your minor children. The payments to minor children have to be reasonable. The minor child needs to be compensated for the services actually performed as a bona fide employee of your business or a corporation.  This tax deduction might be appropriate for some business owners.   Minor child is referred to a child between 7 to 18 years of age.  Each state has different guidance and laws about the definition of minor, so please consult your legal advisor.

Paying minor children has many tax benefits.  For instance, payments to minor children by the parents’ business are not subject to either FICA (Social Security & Medicare Taxes) or FUTA taxation, IRC §3121(b)(3)(A) and 3306(c)(5).  This works great for businesses that are operating as sole-proprietorships or Single Member LLC.  But what about a corporation; can a corporation employ a child of a shareholder?  Based on Rev Rul 72-23 this would be allowed.  However, publication 15 page 10, states that a corporation wholly owned by the parent(s), have to withhold FICA (social security and medicare) taxes from child’s salary.  So consult with your tax advisor about your specific case.  Many taxpayers abuse and do not follow the proper way of paying and documenting minor child’s employment.  To show the legitimacy and legality of this tax deduction, it’s imperative that the business or a corporation keeps proper records and documentation.

How does this work in practice?  For illustration purposes, lets say you are a sole-proprietor and have a printing business.  For 2009 your Accountant or Tax Advisor, estimated that the business will generate a 25K in net income (Revenue minus Expenses).  Your personal federal/state tax bracket is at 30%.  So out of 25K, you will pay about 7.5K in taxes.  You also have 2 kids that can perform legitimate and valid duties for your business.  In 2009 you want to reasonably compensate them for their time and pay them 5K each.  No FICA or Federal/State withholding are required.  By paying 10K to your children, you will reduce your net business income from 25K to 15K.  With that, your tax will be about 4.5K instead of 7.5K – a savings of 3K in taxes!  A parent can also establish a traditional IRA or a Roth IRA on the child’s name and start saving for their retirement early.

How to report child’s wages?  The wages paid to minor children are reported on form W2.  If the total amount of payments or total compensation reported on W2 does not exceed individual exemption currently $5,700 (this amount is adjusted annually for inflation) no Federal, State, FICA or FUTA withholdings are necessary and the minor child does not need to file his/her own tax returns.  When the minor child gets paid, the money can be deposited to child’s custodian account UGMA/UTMA opened under the state law.

If you have decided to hire your minor child, then you need to understand that many states have different rules enforcing and regulating laws relating to the employing of minor children.  In NY for example, in most cases a child of 14 years or older can be employed.  In NJ it ranges between 16-18 years of age.  You need to register the minor child as an employee by filing appropriate forms with your State.  You also need to pay required filing fees, get workers compensation and disability insurances.  So before you do anything, you need to contact your state department of labor or legal advisor.