Can Your Kids Be Employees?

Small business owners operating as sole proprietors can save tax costs by employing their children. Used properly with the right documentation, this approach to tax savings is neither abusive nor illegal. This article is a short course on staying in compliance and using this tax saving strategy properly.

How Can You Hire Your Children?

The name 'Jones & Sons' or 'Peterson Family Plumbing' may not ring a bell with you unless they are the names of local businesses you are familiar with. Yet many small sole proprietors throughout the country have a family-owned business in which their kids are employees. Whether it is a brick and mortar business site or a virtual e-commerce enterprise, many young entrepreneurs of today got their start by first being part-time or full-time employees in a business that was owned and operated by their own parents.

The compensation your unincorporated sole proprietorship business pays to your children is a legitimate business expense, just as it would be to any other employee hired from outside your family. And as long as your children perform business-related duties that are legitimate and not 'made up', you are teaching your children about responsibility rather than cheating on your taxes.

Depending on the amount of income they earn, your kids will have either no tax liability at all or they'll have a relatively nominal amount at a rate that's lower than your own.

What's the Catch?

The

work your kids perform must be real. Simply having an imaginative title does not meet the test. They must perform actual work for the money earned. For example, if your child is employed to do clean-up on rental properties of yours that become vacant, you should be sure to properly document your child's working hours and expected working responsibility. Make sure the duties your kids perform are age-appropriate, and you should pay a 'reasonable wage' for the work actually performed.

Payment to your kids needs to be documented as well. A paycheck for the work performed is best. It makes it very clear who is being paid and exactly what amount. Hopefully your business is using a business check and not a personal check so that documentation is even better. This combined along with your business records as to your child's actual work performed will stand up.

At the end of each business year, your child needs to receive a W-2 for the amount of his or her work-related earnings, just as they would if they were working for another employer outside your family. The W-2 can be used in claiming the tax deduction for your business and in documenting the child's income for an income tax return. Now remember, in 2008 the standard deduction is up to $5,450. Two children working in your business would provide a deduction in the amount of $9,700. While each of your kids would be filing a tax return for the amount of the money they earned, any tax liability they would otherwise owe would be offset by the deduction.

Roth IRA

Your young employee is probably a budding entrepreneur who may be one of tomorrow's business leaders. He or she is learning about the world of work and about earning money for both now and the future. This may be an excellent time to teach your child to save, and how to budget for recreation and personal items. It's also an excellent time to teach them how to invest for their future retirement. After all, the younger your child begins saving for retirement, the less they have to put away each month over the long haul in order to have a comfortable and secure retirement. The older they are when they start, the more they must put away in retirement savings in order to not be dependent on the government or on others for support when they retire.

To start putting money away for their own retirement, kids need to first have 'earned income'. The compensation they receive from your business is a starting point - and can be an excellent opportunity to teach your kids valuable lessons about saving and investing. Even if your child earns more than the standard deduction and has only a nominal tax liability, it's another way to give your child the early benefit of a financial education that most of us don't even begin to learn until much later. How many times have you said to yourself 'I wish my own parents had done that for me'?

ABOUT THE AUTHOR: Michael Potter, Esq. is also known as the One-Minute Tax Coach. An attorney, business coach and popular speaker, Michael teaches workshops around the country that have been attended by thousands. His interactive and engaging workshops on Tax-Advantaged Planning, Accelerated Retirement Planning, Asset Protection, Business and Estate Planning, Avoiding Identity Theft, and Multi-Generation Legacy Planning have given new hope to many in protecting themselves and their loved ones. To learn more, visit either http://www.WealthAdvisors.Net or http://www.OneMinuteTaxCoach.com.