Children under the age of 18 who are employed by their parents are exempt from FICA tax (Social Security and Medicare) on their wages. It is important to note “employed by their parents” means that their parent(s) have a sole proprietorship, single-member LLC or a partnership in which only the parents are members. Small businesses that are incorporated entities or any entity that includes a non-parent member do not meet the exemption. Additionally, children under the age of 21 who are employed by a sole proprietor parent are also exempt from FUTA (Federal unemployment tax).
By employing your children, you are can shelter some income. A child, who is paid by the business and receives a W-2, is entitled to his own standard deduction of $5,950 in 2012. Thus the first $5,950 paid to the child is tax free. The next little bit of their earned income is likely taxed at the lowest tax bracket, Therefore, if the parents are in a higher bracket, this should save some money for everyone.
As a business owner, you can insure a family member for up to $50K while still deducting the premiums. So, if you planned to insure your child, you can get a tax break.
The general rules are simple. The child must perform real work for a reasonable wage. Keep good records of the hours that they worked and be able to explain what they did. The IRS will want to know that the work was age-appropriate. Age-appropriate work can include filing, data entry, sweeping, emptying trash cans, or even modeling in your business’ advertisements.
As you already know, for an individual to be able to contribute to an IRA, earned income is needed. What better way to have your child contribute to an IRA than to have them earn the contribution! The time value of money is a powerful tool–even a small amount of money put away early can grow to a large amount. For example, $5,000 in a Roth IRA at age 15 becomes $585,000 at age 65, assuming a 10% rate of return.
At Henssler Financial we believe you should Live Ready, which includes helping your child’s financial future while helping your business. If you have questions regarding your small-business planning, the tax experts at Henssler Financial will be glad to help. You may call us at 770-429-9166 or e-mail at experts@henssler.com.