It’s summer, and that means your teenage or college-age child might be looking for a summer job. Did you know you can see a tax break by hiring your own child? It’s true, and the deal has gotten sweeter under the Tax Cuts and Jobs Act (TCJA).
We’ve covered this concept before, but it’s worth a revisit. To start, know that wages your child earns are taxable, just as they are for any other employee. However, the TCJA now allows that income to be sheltered from federal income tax by the standard deduction.
Remember that the TCJA increased the standard deduction for a single filer in 2018 to $12,000. That’s far more money than most kids will earn over the summer. You could also see some tax savings, too, which takes the sting out of paying your own child! A taxpayer in the 32% tax bracket ($157,501-$200,000 for individuals; $315,001 to $400,000 married, filing jointly), for example, who pays their child $5,000 for a summer job, can save $1,600 (32% of $5,000).
The tax benefits of hiring your child for summer don’t stop there. Consider the following:
You can deduct the wages paid to your child just as you would for any employee. Just don’t inflate the wages; IRS has strict rules in place regarding “reasonable payment”.
Payroll tax savings
If your child is under age 18 and the business isn’t incorporated (i.e. you run a sole proprietorship) your child’s earnings are exempt from FICA tax. A similar exemption applies to FUTA tax for a child under age 21. Payroll savings like that can be significant.
Your child will be eligible to receive tax-free fringe benefits just as any other employee. Group-term life insurance coverage up to $50,000 and tuition assistance plans are just two examples. Those payments would be deductible by the business, providing you additional tax savings.
Your child’s summer earnings allow him to contribute to a traditional or Roth IRA. The maximum contribution for a child in 2018 is the lesser of the amount earned or $5,500. Generally, contributions to a traditional IRA are deductible on your child's tax return. Contributions to a Roth IRA can’t be deducted, but the funds may be withdrawn tax-free in the future.
Your child could also participate in a 401(k) or other qualified retirement plans, within generous limits. Your child may also benefit from “matching” contributions by the company. Again, these payments would be deductible by the business.
There’s also the issue of the “kiddie tax” which generally applies to a dependent child under age 24 if unearned income exceeds in 2018 exceeds a $2,100 threshold. Previously, the tax was computed based on the parents’ top tax rates. Now, the kiddie tax is based on tax rates for estates and trusts. But this tax only applies to unearned income such as investment earnings. It doesn’t affect earned income like wages from a job.
There are many factors to consider, but hiring your child over the summer could be particularly fruitful. Give us a call to discuss your options and potential tax breaks.