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If you hire your own kids this summer, you might get a tax break

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  • Hiring your children in your small business can offer significant tax advantages, including business expense deductions and potential exemptions from certain payroll taxes.
  • Roth IRAs present a powerful savings opportunity for young earners, offering tax-free growth and withdrawals in retirement.
  • Compliance with labor laws and IRS regulations is crucial when employing family members, including maintaining proper documentation and adhering to age restrictions.

As summer approaches, small business owners and self-employed individuals are exploring innovative ways to optimize their tax strategies. One method gaining traction is hiring your own children, which can offer substantial tax breaks if done correctly. However, it's crucial to navigate the complex landscape of labor laws and IRS regulations to ensure compliance and maximize benefits.

Employing your children in your small business can be a win-win situation, offering both tax savings and valuable work experience for your kids. Sean Lovison, a certified financial planner and founder of Purpose Built Financial Services in Philadelphia, explains, "Engaging your child in your business can be a tax-savvy move. Their wages can be deducted as a business expense, potentially leading to substantial savings for your small business."

The tax benefits of hiring your children are particularly appealing in 2024. With the standard federal deduction for single filers set at $14,600, your child may not owe any income tax if their earnings fall below this threshold. This scenario creates a double advantage: you can deduct their wages as a business expense, while your child potentially pays no income tax.

Furthermore, depending on your business structure and your child's age, you might be exempt from paying Medicare and Social Security taxes on their wages. This exemption can lead to even more significant savings for your business.

Roth IRA: A Powerful Savings Tool for Young Earners

Once your child starts earning wages, they become eligible to contribute to a Roth Individual Retirement Account (Roth IRA). Financial experts tout this as an excellent opportunity to kickstart your child's retirement savings and financial education.

Carol Fabbri, a certified financial planner and managing partner of Fair Advisors in Conifer, Colorado, emphasizes the importance of early savings habits: "It's never too early to instill the habit of saving." A Roth IRA offers a triple tax benefit for young savers: contributions are typically made with after-tax dollars (which is often minimal for children), growth is tax-free, and withdrawals in retirement are generally tax-free as well.

For 2024, the contribution limit to a Roth IRA is the lesser of your child's total earnings or $7,000. This presents an excellent opportunity to maximize your child's long-term savings potential while they're young and have time on their side for compound growth.

Navigating the Legal Landscape

While the tax benefits of hiring your children are enticing, it's crucial to adhere to both state and federal labor laws and tax rules. Matt Metras, an enrolled agent and owner of MDM Financial Services in Rochester, New York, cautions against relying solely on social media for information: "When you have a 60-second video, you aren't trying to convey the nuance."

Before bringing your children on board, consider the following key points:

Age Restrictions: Some states have strict regulations about hiring minors. Lovison notes, "Some states prohibit hiring children under the age of 14 under any circumstances." Be sure to familiarize yourself with your state's specific labor laws.

Legitimate Work: If you decide to hire your children, they must perform real, necessary work for your business. Their compensation should be commensurate with their tasks and age-appropriate.

Proper Documentation: Maintaining accurate records is non-negotiable. Lovison stresses, "Proper record-keeping not only simplifies the tax landscape but also serves as a valuable resource if any questions arise regarding your child's employment."

Tax Withholding: According to IRS guidelines, payments to children are subject to income tax withholding, regardless of their age. To ensure compliance, Lovison suggests hiring children as W-2 employees and withholding taxes. If your child's income falls below the standard deduction, they will receive a full refund of the taxes paid.

Implementing a Tax-Efficient Strategy

To maximize the tax benefits of hiring your children while staying compliant with regulations, consider the following strategies:

Create a formal employment agreement: Outline the job description, hours, and compensation in writing.

Keep detailed time records: Document the hours worked and tasks completed by your child.

Pay a reasonable wage: Ensure the compensation aligns with what you would pay a non-family member for similar work.

Issue regular paychecks: Maintain a consistent payment schedule, just as you would for any other employee.

File all necessary tax forms: This includes W-2s, payroll tax returns, and any required state forms.

Consider opening a Roth IRA: Help your child start saving for the future by setting up and contributing to a Roth IRA based on their earned income.

The Bigger Picture: Financial Education and Family Bonding

Beyond the immediate tax benefits, hiring your children can serve as a valuable opportunity for financial education and family bonding. By involving your kids in the family business, you're teaching them important lessons about work ethic, money management, and entrepreneurship.

Moreover, working together can strengthen family ties and create a sense of shared purpose. It's an chance to pass on your knowledge and skills to the next generation, potentially grooming future business leaders within your family.

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