Hiring Children In The Family Business

Hiring Children in the Family Business

David W. Swatosh, CPAPhone: Ext. 7147

Email: [email protected]

Agenda

• Considerations• Income Shifting • Kiddie Tax Implications• Retirement Savings• Education Credits• Payroll Tax Savings

Considerations

• Pay must be reasonable• Perform work necessary for the business• Pay by check (same as other employees)• File W-2’s and include on payroll tax forms• Follow the Fair Labor Standards Act

Income Shifting

• Shift income from higher (35%) tax bracket to lower tax bracket

• $5,700 (2010) Standard Deduction (Rev. Proc. 2009-50)

• No Exemption Allowed

Example

• Facts: Mom owns S Corp and is in the 33% tax bracket. Son is home from college and works part time earning $6,000.

• What are the tax implications?

Income ShiftingParents:

Child’s Wages $6,000

Tax Rate 33%

Tax Savings $1,980

Child:

Child’s Wages $6,000

Stand. Deduction ($5,700)

Taxable Income $300

Tax Rate 10%

Tax Due $30

• By shifting $6,000 of income the family saved $1,950 in taxes

Kiddie Tax Implications

• Unearned income (greater than $1,900) taxed at the parents tax rates (Sec. 1(g))

• Age Test

• Support Test

Example

• Facts: Mom owns S Corp and is in the 33% tax bracket. Son is home from college and works full time earning $10,000 (more than half of his support) and has dividend income of $3,500.

• What are the tax implications?

Kiddie Tax ImplicationsParents:

Child’s Wages $10,000

Loss of Exemption ($3,650)

Inc. subject to Kiddie Tax $1,600

Total Inc. from Child $7,950

Tax Rate 33%

Tax Savings $2,624

Child:

Child’s AGI $13,500

Exemption ($3,650)

Stand. Deduction ($5,700)

Taxable Income $4,150

Tax Rate 10%

Tax Due $415

• By shifting $10,000 of income and avoiding the Kiddie tax the family saved $2,209 in taxes

Retirement Savings

• Traditional IRA contributions up to $5,000 for 2010 (Sec. 219)

• Tax is deferred until distributed

• Phase-out for single starts at $56,000

Example

• Facts: Mom owns S Corp and is in the 33% tax bracket. Son is home from college and works full time earning $10,000 (more than half of his support) and has dividend income of $3,500. Son also contributes $5,000 to a traditional IRA.

• What are the tax implications

IRA ContributionParents:

Child’s Wages $10,000

Loss of Exemption ($3,650)

Inc. subject to Kiddie Tax $1,600

Total Inc. from Child $7,950

Tax Rate 33%

Tax Savings $2,624

Child:

Child’s AGI $13,500

Exemption ($3,650)

IRA Deduction ($5,000)

Stand. Deduction ($4,850)

Taxable Income $0

Tax Rate 10%

Tax Due $0

• By shifting $10,000 of income, contributing $5,000 to a traditional IRA and avoiding the Kiddie tax the family saved $2,624 in taxes (however may want to consider Roth IRA)

Education Credits (Sec. 25A)

• Hope Scholarship Credit

• Lifetime Learning Credit

• NEW: American Opportunity Credit

• Parents can forgo the dependency exemption for the child (Treas. Reg. Sec. 1.25A-1(f)(2)

Example

• Facts: Mom owns S Corp and is in the 33% tax bracket and is disqualified from claiming education credits. Son works full time and earns $10,000 while home from college (more than half of his support) and had $4,000 in qualifying tuition expenses.

• What are the tax implications?

Education CreditsParents:

Child’s Wages $10,000

Loss of Exemption ($3,650)

Net effect on T.I. $6,350

Tax Rate 33%

Tax Savings $2,096

Child:

Child’s Wages $10,000

ExemptionStand. Deduction

($3,650) ($5,700)

Taxable Income $650

Tax Rate 10%

Tax Due $65

AOTC $1,065

Tax Refund $1,000

• By shifting $10,000 of income the family saved $3,096 in taxes

Payroll Tax Savings

• Child’s earnings could be exempt from FICA and FUTA

• Child must be under age 18 (FICA) or 21 (FUTA)

• Unincorporated businesses or husband and wife partnerships

Circular 230PleasePlease Note: This document is intended for internal training Note: This document is intended for internal training

purposes onlypurposes only

NOTICE TO PERSONS SUBJECT TO UNITED STATES NOTICE TO PERSONS SUBJECT TO UNITED STATES TAXATION: DISCLOSURE UNDER TREASURY CIRCULAR 230TAXATION: DISCLOSURE UNDER TREASURY CIRCULAR 230

The United States Federal tax advice, if any, contained in this The United States Federal tax advice, if any, contained in this document and its attachments may not be used or referred to in document and its attachments may not be used or referred to in the promoting, marketing, or recommending of any entity, the promoting, marketing, or recommending of any entity, investment plan, or arrangement, nor is such advice intended or investment plan, or arrangement, nor is such advice intended or written to be used, and may not be used, by a taxpayer for the written to be used, and may not be used, by a taxpayer for the purposes of avoiding Federal tax penalties.purposes of avoiding Federal tax penalties.