A common set of questions we get goes something like this:
"I'd like to set my son/daughter up as an employee and would like to hear more about how to go about it.
How much can they be paid?
Can I set up with a Roth IRA?
Is there a minimum or maximum limit on that contribution?"
These are great questions. There is a lot of information floating around on the web about this concept, and often, they fail to advise properly on the requirements that must be met for a child to be an employee to justify the wages you will be paying. This can indeed be beneficial from a tax perspective, but you must actually meet the requirements to take advantage.
To be able to answer these questions, we need to cover some groundwork first. Tax filings, forms, time records, payroll records, documentation of business expenses, and record retention. Once we cover these, we can assess potential benefits.
To support the deduction of wages in their business, an employer typically needs to fulfill several requirements, which may include:
Tax Filings: Employers are required to file various tax forms with government agencies, such as the Internal Revenue Service (IRS) in the United States. This includes forms like Form 941 (Employer's Quarterly Federal Tax Return), which reports wages paid to employees and the associated taxes withheld. We can assist or a payroll service can assist with this reporting.
Forms Completed by the Employee: Employees typically fill out certain forms, such as the W-4 (Employee's Withholding Certificate) in the United States, to provide information about their tax filing status and withholding allowances. This helps the employer calculate the correct amount of taxes to withhold from the employee's wages.
Time Records: Accurate time records are crucial for substantiating wage deductions. Employers should maintain records of the hours worked by each employee, including regular hours, overtime, breaks, and any other relevant information. This documentation helps ensure that employees are paid correctly for their time worked.
Payroll Records: Employers must maintain detailed payroll records, which include information such as employee wages, tax withholdings, benefits deductions, and any other compensation provided. These records serve as evidence of the wages paid to employees and are essential for tax compliance and reporting.
Compliance with Labor Laws: Employers must comply with all relevant labor laws and regulations regarding wages, including minimum wage requirements, overtime pay, and other provisions. Adhering to these laws helps ensure that wage deductions are legitimate and lawful.
Documentation of Business Expenses: If the wages are being deducted as a business expense, the employer should maintain documentation to support this deduction. This may include invoices, receipts, or other records showing that the wages were paid for services rendered in the course of conducting business.
Record Retention: Employers are generally required to retain employment and payroll records for a certain period of time, as specified by law. For example, in the United States, the IRS recommends retaining employment tax records for at least four years.
By fulfilling these requirements and maintaining accurate records, employers can substantiate wage deductions and ensure compliance with tax and labor regulations. It's essential for employers to stay organized and diligent in record-keeping to avoid potential issues with tax authorities or labor enforcement agencies.
Obviously, you need to meet all of the above general requirements for your child as well as any other employee you hire. When setting up your child as an employee though, the biggest challenge is regarding the child's age. There have been several US Tax Court cases that have addressed the issue of how young an employee can be when parents hire their children. These cases often revolve around the legitimacy of the wages paid to children who are employed by their parents' businesses. Here are a few notable cases:
Melvin H. Hofheinz, et ux. v. Commissioner (T.C. Memo. 1980-430): In this case, the Tax Court ruled in favor of the taxpayer, allowing deductions for wages paid to their minor children. The court found that the children performed services for the family business, and the wages paid were reasonable and customary for the services rendered.
Geraldine Elizabeth Evans v. Commissioner (T.C. Memo. 1986-530): This case involved a taxpayer who hired her minor children to perform services for her business. The Tax Court allowed the deduction for the wages paid to the children, emphasizing that the payments were for bona fide services and not merely for the purpose of income shifting.
David W. McKelvey and Judith A. McKelvey v. Commissioner (T.C. Memo. 1991-625): The Tax Court ruled in favor of the taxpayers, allowing deductions for wages paid to their minor children for services performed in their family business. The court emphasized that the payments were reasonable compensation for the services rendered and were not solely for the purpose of tax avoidance.
These cases illustrate that the age of the employee, including minors, is not necessarily a determining factor in whether wages paid to them are deductible for tax purposes. Instead, the key considerations often include whether the services performed are bona fide, whether the wages are reasonable for the services rendered, and whether the arrangement is structured for legitimate business purposes rather than tax avoidance.
So if you have made it this far and know you can meet all of the minimum requirements, let's discuss if this will be beneficial for you.
Paying your child as an employee offers several tax benefits. One notable advantage is that you can deduct his wages as a business expense, reducing your taxable income. Additionally, your child's earnings may be eligible for no or reduced income tax brackets. Assuming the wages are less than the standard deduction (14,600 for 2024 adjusted each year for inflation) he will pay no income taxes. If they exceed this amount, they will be subject to the single tax brackets. If you are a single member LLC as long as he is under 18 you will not have to pay any Social Security and Medicare for their wages and their wages are exempt from FUTA and SUTA. Regarding your question about setting up a Roth IRA for your child, yes, that's absolutely possible. A Roth IRA can be a fantastic way to start building long-term savings and investments
Here are some key points to consider:
Contributions: While there's no minimum age requirement to contribute to a Roth IRA, your child must have earned income from working to be eligible.
Limits: As of 2024, the maximum annual contribution limit for a Roth IRA is $6,000 for those under 50 years old.
Tax Benefits: Contributions to a Roth IRA are made with after-tax dollars, meaning your child won't receive an immediate tax deduction. However, the earnings in the account grow tax-free, and qualified withdrawals in retirement are also tax-free.
These funds are often accessible without penalty before age 59 1/2 subject to certain tax provisions for things like education etc
In conclusion, hiring your child as an employee can offer significant tax advantages and income opportunities for both your business and your family. By structuring their compensation package appropriately and following tax guidelines, you can potentially reduce your overall tax liability while providing your child with valuable work experience and income. Consult with a tax advisor or accountant to understand the specific tax benefits available and ensure compliance with regulations. With careful planning and execution, integrating your child into your business team can be a strategic financial decision that benefits everyone involved.