Pocket Tax Breaks for Hiring Your Child

Jun 13th 2018
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Say your small business client needs extra help during the summer and the entrepreneur’s teenaged child is searching for a job while school is out. The obvious solution? Hire the child.

Not only can this arrangement be mutually beneficial, it may provide tax breaks for both the child and the business owner.

For starters, the wages your child earns are taxable to him or her, just like they are for any other employee. However, the income can be sheltered from federal income tax by the standard deduction.

Under the new Tax Cuts and Jobs Act (TCJA), the standard deduction for a single filer in 2018 is $12,000 – way above the amount most children will earn from a summer job. Also, consider that you may be earning less money as a result of paying your child to work in the summer, but you’re saving tax at the same time.

For instance, if you expect to be in the 24% tax bracket in 2018 and you pay your child $6,000 for the summer, you can save $1,440 (24% of $6,000), not to mention state tax savings.

A logical question: What about the “kiddie tax?” This tax generally applies to a dependent child under age 24 if unearned income exceeds in 2018 exceeds a $2,100 threshold.

Due to a change in the TCJA, the kiddie tax is now based on the tax rates for estates and trusts. (Previously, the tax was computed under the parents’ top tax rate.) But this tax only applies to unearned income such as investment earnings. It doesn’t affect earned income like wages from a job.

What’s more, the tax breaks don’t stop there. Here are several other important tax implications for hiring a child for the summer:

  1. Business deductions: The wages paid to your child can be deducted by the business, the same as they would be for any employee. But you can’t arbitrarily inflate the amount. To be deductible, the wages must constitute a reasonable payment for services actually rendered.
  2. Payroll tax savings: If your child is under age 18 and the business isn’t incorporated – for example, you may run a sole proprietorship -- the child’s earnings are exempt from FICA tax. A similar exemption applies to FUTA tax for a child under age 21. These payroll tax breaks can provide significant tax savings for the family.
  3. Fringe benefits: When your child works for your company, he or she is eligible to receive tax-free fringe benefits for employees. This may include health insurance coverage, group-term life insurance coverage up to $50,000 and educational assistance plans. As with wages, payments under a qualified plan are deductible by the business.
  4. IRAs: If your child has earnings from a summer job, he or she can 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. Although contributions to a Roth IRA can’t be deducted, the funds may be withdrawn tax-free in the future.
  5. Other retirement plans: In addition, your child may be eligible to participate in a 401(k) or other qualified retirement plan, within generous limits. Your child may also benefit from “matching” contributions by the company. Again, these payments are deductible by the business.

Conclusion

As shown above, the tax breaks for hiring a child are plentiful, but this may not work out for everyone. Talk things over to see if it’s a good match.

Replies (3)

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Julian Block
By Julian Block
Jun 14th 2018 17:32

Excellent summary of the law changes.

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David Prusinowski
By poolside
Jun 18th 2018 19:04

Great article Ken!

Thanks (1)
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By Skipper50
Jun 19th 2018 15:20

I don't think you're right about the standard deduction. For 2018, the standard deduction for a taxpayer who can be claimed as a dependent by another taxpayer cannot exceed the greater of (a) $1,050 or (b) $350 plus the dependent's earned income.

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