By Ken Berry
If your business clients need extra help, you might suggest they hire their teenage children to pitch in after school or on weekends. This strategy may result in tax savings and other potential benefits if the children are treated as official employees. However, it's important to note that employers must observe all the usual formalities involved in compensating employees.
Let's review some basics:
1) When a business owner hires a child as an employee, the wages paid are taxed to the child at his or her low tax rate. Assuming the higher-bracket parent reduces his or her compensation accordingly, the family can save income tax overall. In addition, there are no kiddie tax complications because earned income from employment is exempt from the kiddie tax.
2) The wages paid by the owner to the child are fully deductible by the business. As an employee, the child also may be eligible for certain benefits, including health insurance coverage and participation in retirement plans and other employer-sponsored programs.
3) If a child under age eighteen is employed by a parent who runs an unincorporated business, the child's wages are exempt from Federal Insurance Contributions Act (FICA) tax. This exemption also applies toFederal Unemployment Tax Act (FUTA) tax for children up to age twenty-one. These employment tax breaks may sweeten the deal for self-employed individuals or partners in a business.
In a recent case, Luis Bulas failed to follow through on certain requirements (TC Memo 2011-201). Bulas has a master's degree in accounting, and he worked for the IRS for seven years as a tax technician, revenue agent, appeals auditor, and appeals officer. In 1985, he started his own accounting practice, preparing approximately 180-220 tax returns per year.
Bulas has two daughters, ages twenty and seventeen. His older daughter was enrolled as a full-time student at Rutgers University, and the younger daughter was in high school. Both daughters provided administrative assistance to the accounting practice in 2007. The business didn't issue a Form W-2, Wage and Tax Statement, or a Form 1099-MISC, Miscellaneous Income, to report wages to either daughter. Instead, Bulas claimed that he paid his daughters' credit card bills, although he didn't provide any evidence to substantiate those payments. Subsequently, the Tax Court denied the deductions for wages paid by the practice.
Moral of the story: Hiring a child can be beneficial taxwise, but you can't take shortcuts. Advise clients to comply with all the tax requirements. And, if you find yourself in the same position, take your own advice to heart.