This article is part of a series of six posts over the next few months on ways of keeping wealth all in the family and away from the IRS.
Because the posts will show in almost every one of our blog categories (Individual,Business,Estate Planning, etc.) the best way to find them all is to use our advanced search engine and click on the “all in the family” tag.
In this article we focus on the family-owned business and ways of keeping profits within the family.
Advantages of Hiring Family Members
For business owners, hiring family members as employees can lead to impressive tax savings. And in many cases, those savings extend to the family members as well as the business owner. Sole proprietorships and corporations are both entitled to tax savings when they hire family members, but the amount of savings varies according to business type.
Sole Proprietorships: Sole proprietors stand to save the most when they employ family members. They’re entitled to special savings when they employ either a child or a spouse.
- Employing children: Sole proprietors who employ their own children are exempt from paying Social Security tax and FICA on those children’s wages until they reach 18. They are also exempt from paying FUTA tax until turning 21. and employers can deduct any wages paid to those children from their net income for tax purposes. The children are exempt from paying FICA as well.
- Employing spouses: The employment of a spouse offers some significant advantages, including savings on FICA tax. When a sole proprietor employs a spouse who also has another job outside the family business, the income from the other job counts toward the sole proprietor’s FICA limit on a joint income tax return. So the sole proprietor may see his or her FICA tax burden reduced.
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Employing spouses can also open new health insurance options. The Obamacare law is being restated almost every month so it’s difficult to compile a permanent list of strategies. For a list of items in the ACA that you should plan for (including the one provision that can affect a business with only one employee), use this link.
Corporations: Corporation owners who employ their own children under 18 can deduct wages paid to those children from their income taxes. This applies up to the earned income limit after which the child would have to file an income tax return. Last year this limit was $6,100.
With either propriertorships or corporations, there’s another way to double the advantage with young children.
Simply layer on an IRA and you can double the amount of savings.
Here’s how it could work.
Your 17-year-old child helps you in delivering business products in the evenings and on weekends throughout the year. For this he receives a W-2 for $9,500.
Although this would generate a small tax liability (at a lesser rate than the parents’), if your son then contributed $5,000 to his IRA from the 9k that he was paid, his tax liability drops to zero.
Remember that your business is getting a $9,500 deduction as well.
Sound too good? Well, we do have a couple of cautions for you.
[Warning – There is a “catch” to all the above ideas!]
The pitpalls in this strategy are easy enough to avoid.
Observe these 3 rules, and you’ll be fine.
- The family member must perform actual work for the business (i.e., something you would do or hire someone to do for the company).
- You must pay a Fair Market Wage (essentially what you would pay an outsider for the work performed).
- Make any and all requirements of the family member that you would demand of any other employee (timesheets, etc.).
Hiring family members can be more than just a needed labor for your business; it can also result in significant tax savings, especially for sole proprietors.
Sometimes tax-savings ideas can come from unlikely sources. IRS lists all the details about hiring children on this section of its website.
David Conley
He is also a founding Board Member and Finance Director of the Fayette Pregnancy Resource Center and serves on the Board of the National Equal Rights Institute.
