Business owner clients often ask me about putting their children on the payroll.  It’s a common strategy that can really save money depending on the number of children you can employ and how much you can reasonably pay them.  Self-employed individuals and partnerships, including LLCs filing as partnerships where the only partners (LLC members) are husband and wife, reap the biggest benefits by employing children.

The beauty of this strategy is the shifting of taxable income from parent (who typically is in a much higher tax bracket) to child.  Depending on the amount of wage paid to the child, the child could pay $0.00 tax.  See example below.

Applicable info to consider

1. Wages paid to children are exempt from Social Security and Medicare withholding as well as employer matching in a parent’s unincorporated business (example = self-employed consultant), a partnership (or LLC filing as a partnership) in which each partner (LLC member) is a parent of the child, or a single-member LLC filing as a sole proprietorship.
2. A dependent’s (child’s) standard deduction ($6,300 for 2016) can be used to offset wages paid to the child.  Simply stated, paying a child wages of $6,300 will go untaxed to the child.
3. Since earned income (i.e. wages) is the prerequisite for making traditional or Roth IRA contributions, the funds paid to your child could be invested for future growth
4. Wages paid by a parent’s business to a child are deductible by the parent’s business if the work is done by the child in connection with the parent’s trade or business.
   1. Caution: Wages paid to a child must be reasonable in relation to the services rendered.  The business owner should keep detailed records of the child’s employment, including payroll records, in case Federal or state taxing authorities or labor departments seek verification.

Let’s take a look at an example:

John is a self-employed geologist operating his business as a sole proprietorship.  His marginal Federal tax rate is 28% and his state tax rate is 6%.  John has a 16 year old son name Carter.  John hires Carter to handle various computer tasks including technical data entry as well as administrative tasks.  Carter works 15 hours per week throughout the year earning $6,000.  John may deduct the $6,000 as wage expense from his business income.  The wages are exempt from BOTH Social Security and Medicare tax and Carter pays $0.00 income tax.

Carter’s tax return calculation:

Wages                                                    $6,000

Less:  Standard Deduction             ($6,300)

Taxable Income                                     $-0-

The beauty of this scenario is that John saves approximately $2,800 between Federal and state income tax as well as self-employment tax while Carter pays $0.00.  To sweeten the deal, Carter could contribute $5,500 (max for individuals under 50) to a Roth because he has earned income, wages.

John could increase Carter’s pay to $11,800 and Carter would still owe $0.00 Federal income tax assuming Carter made a $5,500 maximum traditional IRA (contrast that to a Roth contribution where you do not get a tax deduction) contribution.

Carter’s tax return calculation:

Wages                                                  $11,800

Less:  IRA Deduction                       ($5,500)

Less:  Standard Deduction            ($6,300)

Taxable Income                                    $-0-

As always, the above examples do not illustrate all of the possible measures that can be used to save a few dollars by employing your children and paying them a reasonable wage.  If you have any questions about this technique, feel free to contact us.

Did you receive an IRS notice assessing penalties?

If so, time out.

You may qualify for the IRS’ first­-time penalty abatement (FTA) waiver.  The FTA is an administrative waiver that the IRS grants to taxpayers providing relief from failure ­to ­file, failure to ­pay, and failure to ­deposit penalties if certain criteria are met.  The policy behind this procedure is to reward taxpayers for having a clean compliance history; everyone is entitled to one mistake.  Individuals and businesses may request FTA for any failure ­to­ file, failure to ­pay, or failure ­to ­deposit penalty.  FTA does not apply to other types of penalties such as the accuracy ­related penalty.

To qualify for the FTA waiver a taxpayer must meet the following criteria:

1. Filing compliance:  Must have filed (or filed a valid extension for) all required returns and can’t have an outstanding request for a return from the IRS.
2. Payment compliance:  Must have paid, or arranged to pay all tax due (can be in an installment agreement as long as the payments are current).
3. Clean payment history:  Has no prior penalties (except an estimated tax penalty) for the preceding three years.
   1. Note:  If the taxpayer received reasonable cause relief in the past, he/she is still eligible for FTA

Another thing to consider is that the penalty notice may be erroneous which happens often.  We may not need to request the FTA.  Simply sending a letter to the IRS detailing specific items might resolve the issue.  So, before you move forward or make a payment, give us a call at 337.406.1099 or contact us today and we’ll review the penalty.  We’ve been successful in requesting waivers and getting penalties abated.