If you own a business, you may be able to hire your child
As a small business owner, you're likely always looking for ways to save money and improve your bottom line. One strategy that's worth considering is hiring your child as an employee. This can provide a number of tax benefits, and could potentially save you a significant amount of money come tax time. In this blog post, we'll explore some of the key tax advantages of hiring your child, as well as some relevant caselaw that could impact your decision.
Tax Benefits of Hiring Your Child
One of the primary tax benefits of hiring your child is that you may be able to deduct their wages as a business expense. As long as you're paying your child a reasonable wage for the work they're doing, these wages are fully deductible. This means that you'll be able to reduce your taxable income by the amount you pay your child, potentially resulting in significant tax savings.
Another advantage of hiring your child is that you may be able to avoid paying certain payroll taxes. For example, if your child is under the age of 18, you may not be required to pay Social Security and Medicare taxes on their wages. This can represent a significant savings, particularly if your child is earning a substantial amount of money.
Finally, there may be additional tax benefits to consider if you're operating as a sole proprietor or a partnership. In these cases, hiring your child could potentially reduce your self-employment tax liability. This is because your child's wages will be subject to regular income tax withholding, but not self-employment tax. This could result in a significant savings, particularly if your child is earning a substantial amount of money.
Caselaw and IRS Challenges
While hiring your child can provide significant tax benefits, it's important to be aware of relevant caselaw and potential IRS challenges. In particular, the IRS has been known to challenge business owners who hire their children for tax purposes, particularly if they feel that the wages being paid are not reasonable. In order to take advantage of these tax benefits, you must follow certain rules and regulations when employing your child. First and foremost, you must treat your child as any other employee and pay them a reasonable wage for the work they perform. This means that you cannot pay your child an excessive amount simply to reduce your tax liability. Additionally, you must keep accurate records of your child's work hours and duties, just as you would with any other employee.
It is also important to note that the IRS has challenged the use of this tax strategy in the past. In the case of Lohrke v. Commissioner, the IRS challenged the deductions claimed by a business owner who had hired his children as employees. The IRS argued that the wages paid to the children were not reasonable for the work performed and were simply being used to reduce the business owner's tax liability. The business owner ultimately beat the IRS, but the analysis of what is reasonable is a fact-intensive inquiry.
In general, it's important to make sure that the wages you're paying your child are reasonable given the work they're doing. This means that you should be able to demonstrate that your child is performing legitimate work for your business, and that the wages being paid are commensurate with the work being done. No toddlers are doing substantial work for a construction business.
Conclusion
Hiring your child can be a smart tax strategy for small business owners. By paying your child a reasonable wage for legitimate work performed, you can deduct their wages as a business expense and potentially reduce your taxable income. Additionally, you may be able to avoid certain payroll taxes and reduce your self-employment tax liability. You should make sure that the wages being paid to your child are reasonable given the work being done, and be prepared to defend your deductions if challenged by the IRS.
At Safeguard Law, PLLC, our experienced attorney can help you evaluate your options and determine whether hiring your child is a good strategy for your business. We can also help you ensure that your business is in compliance with all relevant tax laws and regulations, and help you defend your deductions if necessary.