Own a family business? Why not hire your teenage child?
Many family businesses “hire” their children to work for them but pay them cash under the table. The two reasons for this are 1) they don’t want to have to deal with payroll and 2) they don’t want the child to have to pay taxes and file a tax return. If you fall into this category, you are over paying your taxes by not claiming all of your deductions.
As most of you are aware, when you pay an employee, you have to withhold federal income tax, Social Security, and Medicare taxes. You also must match the employees “contribution” to Social Security, and Medicare. This is why many small businesses pay people under the table. What many people do not realize is there is a tax loophole for a sole proprietorship to hire their teenage children, under age 18, and not to have to pay Social Security and Medicare taxes. They don’t have to withhold it, or match it. The catch is the child must be working in the business, you cannot pay an older child babysit a younger sibling, or mow the lawn while you work at the family restaurant.
But what about federal income tax?
For tax year 2017 the standard deduction for a dependent is the higher of $1,050 or the child’s earned income plus $350, but is capped at $6,350. So, what this means is that you can pay your child up to $6,350 and they will not have to pay any federal income tax. Each state is unique and some local townships are now charging earned income taxes, so your child may still incur some state or local payroll taxes.
Let’s look at an example. In 2016, John and Barb had a small sandwich shop. They have one 14-year-old daughter Jane that works under the table. The business made a net income of $150,000 and they paid Jane $5,000 that was not deducted to arrive at the $150,000. There total taxes due for the year were $39,227. This is their federal income tax of $20,516 and the “self-employment tax” (social security and Medicare) of $18,711.
If John and Barb had put Jane on the payroll they could have deducted the $5,000 bringing their net income to $145,000. Their total taxes due for the year could have 37,860. This is their federal income tax of $19,283 and the “self-employment tax” (social security and Medicare) of $18,557.
| Gross |
$ 150,000 |
$ 145,000 |
Savings $1,367 |
| Federal |
$ 20,516 |
$ 19,283 |
| Social Security & Medicare |
$ 18,711 |
$ 18,577 |
|
$ 39,227 |
$ 37,860 |
That is a savings of $1,367 for John and Barb. Jane now has a w-2 showing $5,000 with no federal, Social Security, or Medicare taxes withheld and because the $5,000 is less than her standard deduction, ($5,000 + $350) she owes no federal income tax.
Now, of course, you may incur some minor payroll processing fees and the child may get hit with some minor state and local taxes – but if you saved $1,000 per year per child, that could really add up – especially if you have more than one child working for you! What you do with that $1,000 is up to you, but you should check out our upcoming blog post about how to set your child up to become a millionaire!
If our business is not a sole proprietorship there is a workaround, just give as a call at (856) 226-9524
Jeff Chapman has a Masters of Science in Taxation and operates our full service office in Media, PA.
