Tax Benefit of Employing Your Child
Tax Cuts & Jobs Act Applied to Your Business Expenses
Standard Deduction Benefit
The Tax Cuts and Jobs Act changed expensing, depreciation, tax credits, deductions, and other tax items for taxable years after December 31st, 2017 and before January 1st, 2026. This tax reform eliminated personal exemptions, but there is a way that the TCJA might benefit you even more with your child.
The quick answer on how this helps you and your child; the standard deduction was $6,350 in 2017 to $12,000 in 2018. This standard deduction increases every year too. The IRS has the tax inflation adjustments posted to their website.
So, how does paying your child say you and your child taxes?
I think the easiest way is to show you an example. You have two kids, eleven and thirteen years old. Both of them work part time in your office during the summer or after school, and you pay them a reasonable rate for employment. For 2022, the standard deduction is $12,950. This mean the first $12,950 that your child earns will be tax free of federal income tax. The business and your child will have to pay the FICA taxes, but the business gets their share of the FICA taxes as a business deduction.
For your income, you are in the 35% tax bracket and just paid out $25,900 plus the business paid half of the FICA, so the total business expense is $27,881. By having the two children employees, you saved $9,758 in federal taxes on your personal 1040.
Now you are thinking, isn’t there a Kiddie tax? Yes there is a kiddie tax, but the tax applies to unearned income and does not apply to earned income. Since you are paying your children with W2 earned wages, there isn’t a kiddie tax on this income. Compensation has to based on services actually rendered, actually paid, and reasonable in amount.
Here are a few tips on building an Audit Proof Support
Require a time sheet
Hand written time sheet are a great way to show proof that your child was working. This time log would be weekly or bi weekly, depending on your payroll cycle, and turned in for the W2 wages paid to them. Written evidence is an excellence source for proving more than just a time sheet.
Make sure you have an Employer ID. The IRS will generate this number for you. If you need assistance, we provide this service for you. We will assist you with everything you need to be established and pay any of your employees.
Document the Pay Rate
Pay with a W2 Payroll Check
The expense has to be an actual transactions and not just an accounting journal entry. You will want to prove that the funds were paid. The W2 is what actually exempts the dependent child from paying the federal income tax and avoiding the kiddie tax. Showing the withdraw from your business checking account to the child’s bank account is the proof you will want to show. We provide the payroll service, and create year-end tax forms like the W2 for your business.
Complete all Federal and State Payroll Forms
We provide this service for all of our clients, so you don’t have to stress over extra tax forms throughout the year. The main forms are W4, , W2, IRS 941, IRS 940, and SUI.
Enjoy the tax benefit! Now to learn about home office expenses.