Today I hired my first employee, Miss. M. Ingram – Administrative Assistant! Of the three candidates who applied – Miss Ingram and her two younger brothers – her maturity, proven leadership, and ability to spell her new job title learn more about the business made her an easy choice!
As small business owners, we have the unique ability and opportunity to employ our children. Aside from teaching them the skills required to be a successful entrepreneur and planting the seeds of a healthy work ethic, there are many tax benefits.
- Wages paid to children between ages 7-17 are deductible and will therefore lower your taxable business income.
- If your child employee is under age 18, you do not have to withhold social security and medicare taxes (FICA) from their income.
- If your child employee is under age 21, you do not have to pay Federal Unemployment Tax Act (FUTA) taxes.
- Income earned by your child employee that is below the standard deduction amount, $6,200 for 2014, is not taxable and your child is not required to file taxes (although I recommend they do so anyway).
- Your child employee can open a Roth IRA and annually contribute the lessor of $5,500 or their earned income. (A Roth IRA is one of my favorite accounts because the interest it earns grows tax free!)
Here’s an example:
Let’s say you’re in the 25% tax bracket and you paid your child $3,000 during the year. You, the employee, can deduct these wages on Sch C, line 26 and save $750 ($3,000 x 25%). Additionally, because your profit is lower, your self-employment (SE) taxes are reduced by $459 ($3,000 x 15.3% SE tax). Your total tax savings is $1,209!
In order to qualify for this deduction, you must meet a few requirements. First, your business must be unincorporated. This just means it’s set up as a sole proprietor, a partnership in which each partner is a parent of the child, or a LLC. Second, the work they perform must be necessary for the business. Although my daughter makes a great cup of french vanilla coffee and is a pretty good cook, those tasks are not essential to my tax or financial counseling business operations. Lastly, wages must be reasonable for the work being done. If you wouldn’t pay someone unrelated to you $50 an hour to perform the same work, then you shouldn’t pay that amount to your child. Use your state minimum wage amount as a guide to determine fair compensation.
Now that we’ve gotten that out of the way and you’re ready to move forward, here are the steps you need to follow.
- Check Federal and State Labor Laws – The federal government and every state has child labor laws you must abide by. Read over them to ensure you’re not in violation of any of them.
- Apply for an Employer Identification Number (EIN) – This step only takes about 10 minutes and can be done online. Once you’ve been assigned an EIN, you are required to use it on all IRS tax forms and correspondence instead of your social security number.
- Create, Review and Sign an Employment Agreement – Sample agreements can be found on the Internet or email me for a copy of the one I used. The agreement should clearly outline your child’s responsibilities, compensation amount, how often he/she will be paid, and any other terms and conditions relevant to their employment. Both of you will sign and date this document on their first day and keep it on file.
- Order business checks – I don’t use business checks for any other business expenses, so this will be an easy way for me to document pay. Just like any other expense for your business, you should keep your personal and business expenses separate.
- Print out and help your child complete Form W-4 and Form I-9 – Do not submit these forms to the IRS. Complete them on your child’s first day of work and retain them in the event you need to prove employment.
- Keep track of time – I’m using the Hours Keeper app on my iPad, but any organized, written format will do. Just like any other job your child might hold, it’s their responsibility to clock-in and clock-out accurately. This is a great way to reinforce the idea that “time = money”!
- File Form 940 and Form 944 by 31 Jan – When you receive your EIN assignment letter, it will detail the filing requirements for the next two forms. Form 940 is used to annually report FUTA taxes if you paid wages above $1,500 per quarter. Remember, if your child is under age 21 you do not have to pay this tax, just submit the completed form by the deadline. It’s likely the IRS will send you a notice informing you Form 940 is no longer required. However, continue to file it until they say otherwise! Form 944 is used to annually report FICA taxes of less than $1,000 you withheld from your employee’s pay. If your child is under age 18, you do not have to collect this tax, just submit the completed form by the deadline. It should take you roughly 30 minutes to complete all three forms.
- Complete Form W-2 by 2 February – You must give your child a W-2 reporting the total wages they earned for the year by this deadline.
- Help them file their taxes – Although it is not required for children who earn less than $6,200, I plan to take advantage of this opportunity to equip my child with this valuable life skill: completing and filing a 1040. Finally, keep in mind, if your child will be applying for college financial aid within the next year, the amount they earn will be a factor in determining need.
