Pay Your Kids, Cut Your Taxes: The Basics
Mar 16 '00
Yes, your children can give you a wonderful opportunity to both cut down on your taxes and increase your family wealth.
This article is based upon some personal experiences after reading a book by Jeff Schnepper several years ago called “How to pay zero taxes”. It comes out every year and is a must-read for great ideas. If you own your own un-incorporated business (like being a part time author) this is for you. Again, like all my financial Epinions you should consult a tax professional and also determine if you’re going to make enough money this year to make it be worthwhile. I figure there are enough people trying to make money out of servicing the Internet economy; including a ton of stay-at-home moms !!
You should read my other Epinion about “Cut Your taxes With Epinions” to learn about the IRS definition of intending to make a profit. So …
This is the process you follow.
1. Hire your Kids
Assuming your kids are under 18 you do not have to pay Social Security or Medicare taxes, and usually nothing at the State level either. The tax court has ruled that you can pay kids as young as seven (yes, 7) reasonable wages for performing any duties related to your business. The duties could be tidying up the office, filing documents, website design for a teenager, or for time spent helping you conduct and write a review. Reasonable means exactly that. You cannot pay your 11-year-old $30 an hour for filing papers. But you could pay your teenager that for building a website for you !!
2. Keep Written Records
The IRS requires you to substantiate the deductions. This is a fancy way of saying “Prove It”. I’d recommend pay the children with a check, and record on a timesheet the hours they spent working and what they did. The kids can then endorse the check back to you, or better yet save the money for college.
Mr.Schnepper also recommended that you write to the State Labor Dept. to check that hiring your under-age kids is not a violation of state laws. It isn’t – but their reply will provide further proof that you are intending to run the business for a profit, and its more substantiation. Only an accountant could love that word.
3. More Records
Give your kids a W2 form at the end of the year. You can get these at any office store. This way you are again substantiating what they were paid, and have a form to send to the IRS.
So lets do the math. You have one kid, aged 15. For 1999 you can pay your wonderful offspring up to $4300 without them having to pay any federal taxes on that income. You could also sock away another $2000 into an IRA or Roth IRA and they wouldn’t have to pay taxes on that either. Meanwhile you can deduct the full $4300 or $6300 as wages paid by your business to offset any income you have. So for $6300 paid to the kid you save (assuming a 28% tax rate), 0.28*6300 = $1764 in taxes . If, like me, you don't make that much in your business, pay what you can.
The downside
The money belongs to the kid. So if they decide at age 18 to blow their college fund on some bright red sports car – tough!! Also, any financial aid offered by colleges may be very slightly reduced, as college kids are expected to contribute more of their assets to education (as a %) than the parents. You will have a little extra paperwork to do mainly dealing with the state you’re in and may potentially have to pay state taxes for the kids.
Nothing here is away on the leading and bleeding edge of tax law. It doesn’t increase your chances of an audit. The next article (Pay Your Kids – Cut Your Taxes : Advanced) deals with some creative things to do when your children are just about to enter college.
And remember, if you buy Jeff Schneppers book – that’s a tax deductible expense too !!
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