As you approach year end you may want to consider paying your child for work done throughout the year to help avoid federal income tax on up to $12,000 per child and reduced rates on excess amounts, depending on your federal tax rate. You should consult your tax advisor for specific savings and be sure to issue the bonus with a pay date of 2018.
If you operate your business as a sole proprietorship, as a single-member LLC that is treated as a sole proprietorship for tax purposes, as a husband-wife partnership, or as an LLC that is treated as a husband-wife partnership, there are additional savings. You can hire your under-age-18 child and his or her wages will be exempt from Social Security tax, Medicare tax, and federal unemployment (FUTA) tax.
Tax advantages for you
You can deduct your child’s wages as a business expense on your business tax returns. Your child can shelter the wages from federal income tax with his or her standard deduction ($12,000 for 2018), and your child can use the wages to fund annual Roth IRA contributions.
The Roth IRA opportunity
Your child can contribute the lesser of: (1) his or her earned income (wages) or (2) $5,500. While the same $5,500 contribution limit applies equally to Roth IRAs and traditional deductible IRAs, the Roth option is usually better for kids for several reasons.
First, your child can withdraw all or part of the annual Roth contributions — without any federal income tax or penalty to pay for college or for any other reason. However, Roth earnings generally cannot be withdrawn tax-free before age 59½. In contrast, if your child makes deductible contributions to a traditional IRA, any subsequent withdrawals must be included in gross income. In addition, traditional IRA withdrawals taken before age 59½ are subject to a 10% early withdrawal penalty tax unless an exception applies (one exception is to pay for qualified higher-education expenses).
Although traditional IRA contributions are deductible and Roth contributions are not, a child’s standard deduction generally will shelter up to $12,000 of earned income from federal income tax. Any additional income may be taxed at lower rates than you are subject to.
Keep in mind the child’s wages must be reasonable for the work performed. Be sure to keep records to substantiate hours worked and duties performed (e.g., timesheets and job descriptions), and issue your child a W-2 just like any other employee.
BE SURE TO CONSULT WITH YOUR TAX ADVISOR TO SEE HOW THIS MAY APPLY TO YOU AND YOUR CHILD OR FEEL FREE GIVE US A CALL