Saw this in my email today. Sounds like a great strategy.
How to Pay for Your Children’s School or Automobile or College and get a Tax Deduction
High net-worth individuals (even non-business owners) often use this strategy to hire their children as employees to pay for private school, cars, and much more while at the same time, getting a nice tax deduction.
How is the possible?
Hiring your children doubles as an underutilized personal finance tactic with a variety of benefits. Below, we’ll tell you what the tax advantages are, how to do it legitimately, the good habits it builds, and why it is also an excellent finance tool for both you and your child.
Tax Advantages
If your business has excess money at the end of the year, that will count as your personal income. The result is that money is taxed at your regular tax rate. This is often upwards of 35% when you consider both state and federal taxes. When you hire your child, they will not have to pay any taxes up to $12,000 (their standard deduction) in income for 2018. After that, they will pay taxes, but at a much lower rate than you (only 10% to 12% in the next $38,700 federal). The effect of this method is that your family pays fewer taxes overall and becomes richer because of it.
An additional benefit is the payments to your children do not incur payroll taxes (FICA - Social Security & Medicare, 15.3%) in addition to regular income tax. Such is generally applies to only an LLC (taxed as a partnership) or sole proprietorship, but there are ways to make it work for corporations too. Some accountants have helped their clients by establishing an LLC separate from your corporation and paying your child from that entity. One thing to note is that this works for children under 18, but once they are over 18, you will need to withhold payroll tax no matter what.
Not a Business Owner? What if others employ you?
Are you a physician without business? If you have an LLC for investing in real estate or real estate funds, talk with CPA to engage this tax strategy. There are many ways for the employed to establish a company so do not discount it if you’re not a traditional business owner.
Do It Legitimately
There is a fine line between a smart tax strategy and illegal tax evasion. When you hire your child, you need to do everything by the book to avoid acting against the law. The best way to stay safe from the IRS is to have your child be a legitimate employee. That means they regularly carry out tasks that directly help your business. Don’t think that you can skirt this rule by having your child do something like chores around the house. That won’t stand up in an audit (ever seen an auditor laugh?). Instead, have them do real work, keep records of the time they spend on it, pay them with company checks, and keep good records in case there is ever an audit.
Learning Good Habits
One of the best things you can do for your child is teaching them to manage money. Usually, parents do this by giving their kids a small allowance. The allowance doesn’t teach them the responsibility of delivering value in exchange for an income.
When you hire your children and pay them a substantial wage (but commensurate with what you would pay someone else for the same work), you give them an opportunity to manage real sums of money. You will want to oversee this process, of course, but you can give them more responsibility as they learn.
The result will be a young adult that is better equipped for the real world than most. A further benefit is what we referenced to above. You can give your child all of the skills of having a real, paid job at a young age. Thus, this will make them a desirable employee or business owner down the road plus become a contributing member to society.
How Can Your Child Use the Income?
The income paid to your children could be used to pay for private school, college, cars, sports camps, clothes or anything they desire. However, it should not be used for paying for necessities like room and board. That could affect whether they remain a dependent for tax purposes. But anything beyond essentials is fine, like a private school (since public school is free), fancy clothes instead of basics, etc.
Investing for The Future
This strategy has the advantage of providing an opportunity to help your child set up a budget for spending and investing this earned income. One idea is to help them set up an IRA. Every month you and your child can funnel excess wages into that IRA, allocate that money among various assets, and watch that money grow over time. Remember, the first $12,000 incurred no tax.
What if they funded a Roth IRA with the earnings? You and your child just funded a deductible Roth IRA!
The beauty of this comes from two factors.
The first is that you can use this as a college fund. Once your child goes to college, they can pull money out of this IRA to pay for school expenses without taxes or penalties. Not only will this money have never been taxed throughout the entire process, and will likely have grown over time through compound interest.
Second, any funds left over after college can continue to grow and become an excellent retirement fund. This way, you can set your child up for the future by giving them a college degree and an honest retirement account. In a world where taking out loans for college is standard and saving for retirement is rare, having these two advantages will be significant factors in propelling your kids to success.
When you go over all of the benefits of this strategy, it becomes clear that you have to give it a try. First, you can reap the tax benefits, which will make your business and family richer.
Next, you can set your child up for the future through gaining sound financial habits, a good work ethic, learning how to be a good employee, seeing how to run a business, and providing a nest egg of capital in the form of a retirement fund. Best of all, this method is completely safe and legal, as long as you follow a few simple rules. Hiring your children is too good of a deal to pass up, so don’t hesitate. Start exploring this option today.
