SAVE TAXES BY HIRING YOUR CHILDREN (PART 2)

Last week I talked about hiring your children. Here is additional information that you need to be aware of.

What about income tax withholding?

Your business may have to withhold federal income taxes on your child’s wages. It is possible for the child to avoid withholding by claiming exempt status if he or she:

• had no federal income tax liability for last year, and
• expects to have none for this year.

However, exemption from withholding can't be claimed if:

• the employee's income exceeds $950 for 2011, and includes more than $300 of unearned income (such as dividends), and
• the employee can be claimed as a dependent on someone else's return.

Keep in mind that your child probably will get a refund for part or all of the withheld tax when he or she files a return for the year.

Social security tax savings too.

If your business is not incorporated, you can also save some self-employment (i.e., social security) tax dollars by shifting some of your earnings to a child. That's because employment for FICA tax purposes doesn't include services performed by a child under the age of 18 while employed by a parent.

Example:
Let’s say a sole proprietor who usually takes $120,000 of earnings from the business pays $5,800 to her 17-year-old child in 2011. The sole proprietor's self-employment income would be reduced by $5,800, saving her $168.20 (the 2.9% Medicare portion of the self employment tax she would have paid on the $5,800 shifted to her daughter). This doesn't take into account a sole proprietor's income tax deduction for one-half of his or her own social security taxes.

A similar, but more liberal exemption applies for FUTA, which exempts earnings paid to a child under age 21 while employed by his or her parent.

The FICA and FUTA exemptions also apply if a child is employed by a partnership consisting solely of his parents.

Note that there is no FICA or FUTA exemption for employing a child if your business is incorporated or a partnership that includes non-parent partners. However, there's no extra cost to your business if you're paying a child for work you'd pay someone else to do anyway.

Keep in mind that some of the rules about employing children (such as the maximum amount they can earn tax-free) change from year to year, and may require your income shifting strategy to change too.