Hire Your Child— It’s A Win Win

Own a business? Consider hiring your child. The new Tax Cuts and Jobs Act (TCJA) offers a host of benefits and can be a smart tax-saving strategy for employee and employer alike.

For you:

If you hire your child, you get a business tax deduction for employee wage expenses. The deduction reduces your federal income tax bill, your self-employment tax bill (if applicable), and your state income tax bill (if applicable.)

For your child:

Your child’s wages are exempt from Social Security, Medicare, and FUTA taxes, if:

  • Your child is a legitimate part-time or full-time employee of the business
  • Your business operates as a sole proprietorship, a husband-wife partnership, or an LLC that’s treated as a sole proprietorship or a husband-wife partnership.
  • Your child is under 18 (or under age 21 for FUTA taxes)

*Corporations are not eligible.

In 2018, your employee-child’s first $12,000 of wages, will be federal tax free. Nearly double the 2017 standard deduction of $6,350!  This allows your children to save more and possibly contribute to a Roth IRA.

Saving for The Future—Roth IRA vs. Traditional IRA

Encouraging your child to save is the next step. This is a great way maximize their savings and begin saving up for their future.  It also introduces the idea of tax planning early on.

For your child to be eligible to make annual Roth IRA contributions, they have to earn income for that year that at least equal’s what they contribute. Age is completely irrelevant. For the 2018 tax year, a working child can contribute the lesser amount of:

  1. His or her earned income, or
  2. $5,500

Most children may be reluctant to contribute the $5,500 annual maximum but because of the rate of return, the more money contributed, the more their Roth Account will be worth years down the line.

The $5,500-contribution limit applies both to Roth IRA and traditional deductible IRA but for children, the Roth option usually makes more sense. This is because your child can withdraw all or part of the annual Roth contributions— without any federal income tax or penalty. However, Roth earnings generally can’t be withdrawn tax-free before age 59.5. Still, the best strategy is to leave as much as possible in the Roth Account for retirement in order to accumulate a larger federal income-tax-free sum.

When it comes to traditional IRA contributions, the only benefit are the tax deductions. However, since your child will automatically get $12,00 tax free, they won’t get any meaningful tax breaks anyway. And, any additional income will most probably be taxed at a low rate. So, unless your child has enough taxable income to owe a significant amount of tax, the Roth IRA would be the preferred model.