Tax Benefits For Hiring Your Children

Many home based business owners put their kids to work helping out with easy tasks such as emptying the trash, stuffing envelopes, and maybe even some light data entry tasks (depending on how old the children are).

Getting your kids involved in your business is a great way to teach them about money, responsibility and business. But there are many tax benefits for hiring your children as well.

Did you know that you can take a tax deduction for the wages you pay your kids? And that they may not even owe taxes on the income they earn?

This hub will show you the tax benefits of hiring your children, the steps you need to take to make your kids legitimate employees and more.

Hiring your children is a great tax planning strategy, but it's more than just a tax deduction. Here are five tax benefits to hiring your children in your small business:

1. Tax deduction - you get a tax deduction for the wages you pay your kids, which reduces your taxable income.

2. Income shifting - you shift income from your higher tax bracket to your child(ren)'s lower tax bracket which saves taxes for the entire family.

3. Reduce self employment tax - not only do you reduce your taxable income, but you reduce your self employment income, which reduces your self employment tax.

4. Tax free income for the kids - your kids may not owe any tax on the amount you pay them depending on how much they earn and whether you claim them as a dependent or not.

5. Jump start your children's savings - paying your children a wage allows them to open an IRA or Roth IRA, which gives them a jump start on saving for thier own retirement, college and other goals.

When you hire your children in your business, you need to make it a legitimate business activity. Otherwise, the IRS may disallow you the deduction and the other tax benefits of hiring your kids.

Here are some tips to treating your kids like true employees:

1. Pay your children with a check. They can endorse it back to you to get cash if necessary. Keep a running paystub just like you would with a traditional employee.

2. Make your children keep a time-sheet. Keep track of the activities they do in your business as well as the time spent on each activity.

3. Give your kids a W-2 at the end of the year. You don't want to give them a 1099 - that will cause them to owe self employment tax.

4. You'll also need to file payroll reports for your children (federal and state) even though no tax will be due.

Following these steps will tell the IRS that you are treating your child like a legitimate employee, not just a tax deduction :)

Now that you've decided to hire your children in your business, do you need to report the wages you pay to them?

Yes, if you want to get all of the tax benefits of hiring your children, you need to treat them like legitimate employees and report their wages accordingly.

Just like with traditional employees, a W-2 needs to be filed for each child that you have paid to do work in your business. You also need to file quarterly payroll tax reports to both the federal government and your state and local government.

However, if your child earns less than the standard deduction ($5,450 in 2008), he or she won't owe any taxes on that income. And remember, you get a tax deduction for the amount you pay your child(ren), which reduces your taxes.

Preparing payroll tax reports are definitely no fun, but as you can see, this strategy is a win/win for both you and your children, so it's definitely worth the extra paperwork.

As kids get older, it is inevitable that they will want more money to buy things like clothes, music, a new car, etc. Many kids will get a job or even start their own company to meet their demand for more "stuff".

While most kids don't earn enough money to worry about filing a tax return, some will be required to file based on the type and amount of income they earn. How do you know when your child is required to file a tax return?

In general, children who are dependents (claimed on someone else's tax return) must file a tax return if:

- they have earned income of $5,700 or higher (this is the standard deduction amount for 2009, the amount for 2008 was $5,450)
- they have unearned income (investment income) of $950 in 2009 ($900 in 2008)
- they have gross income (both earned and unearned) in excess of the larger of $950 or their earned income plus $300.

Continue reading "When Are Kids Required To File A Tax Return?"