Gregory S. DuPont
Family Employees Bring Home Tax Benefits
If you are an owner of a small business, employing your spouse and children can help reduce both your family’s aggregated income subject to taxation, as well as the effective rate at which that income is taxed. This applies whether you are running your business as a corporation, partnership, or sole proprietorship. Putting a family member on your payroll makes that person’s income—and the proportional costs of his or her employee benefits— deductible business expenses. As a result, the gross income of your business is lowered, thereby lowering your family’s aggregated taxable income.
Let’s say, for example, your wife Janet’s take-home pay from her job as a sales manager at the ABC Corp., is $100,000 per year. That amount is included in your family’s income, likely pushing you into a higher tax bracket. But, if Janet works for you as a sales manager earning the same amount, her taxable income will provide your business with a deductible expense, ultimately lowering your family’s overall tax liability.
Good News—Now and LaterNow, suppose that you and Janet have a teenage daughter, Sharon, who has good computer skills. If you directly pay Sharon the going rate for maintaining your database, and keep a record of her hours and the work performed, her salary is tax deductible as a business expense. As long as her wages are less than $6,300 (the standard deduction for 2015), her income will be nontaxable. Income above that amount will be taxed at Sharon’s presumably lower tax rate. Putting Sharon on your payroll, however, means you cannot claim her as a dependent.
Now, imagine that daughter Sharon is still an infant. If Janet, your spouse, works in your business, the cost of paying for childcare while she works will be lessened through the allowable childcare tax credit for such expenses.
If it were 20 years into the future, having Janet on the payroll could help out with your retirement planning. Subject to the terms of the plan—and your business not maintaining a defined contribution plan—your business’s pension, or defined benefit plan, which qualifies under the Employee Retirement Income Security Act of 1974 as amended, (ERISA), allows Janet to receive an annual minimum distribution of $10,000. That’s regardless of whether her annual salary ever got that high. Most importantly, during her 20 years of service, your business was able to deduct contributions to the plan on her behalf from gross income.
Perhaps your business offers a 401(k) plan, a type of defined contribution plan. Then, the contributions made by your business to Janet’s account, up to a certain amount, also qualify as a tax-deductible business expense.
IRAs: Your Family’s Friend If your business does not offer a qualified retirement plan or family members like Janet and Sharon do not participate in such a plan, then Individual Retirement Accounts (IRAs)—available only to employed individuals or their spouses—are an option. IRA contributions may be tax deductible for the employee (but not to the business), and allow for tax deferral on earnings until withdrawal. In 2015, individuals can make tax-deferred contributions of up to $5,500 (or $6,500 for those aged 50+) to an IRA. Meanwhile, Savings Incentive Match Plan for Employees (SIMPLE) IRAs allow annual tax-deductible salary deferred contributions of up to $12,500 (or $15,500 for those aged 50+). Contributions that are matched by the employer are deductible as a business expense. Simplified Employee Pension (SEP) IRAs also allow employer contributions of up to 25% of the eligible employee’s compensation (limited to compensation of $265,000). In addition, you and your employees may make regular IRA contributions to the same account.
In Sickness and In HealthAs employees, Janet and Sharon are eligible for other employee benefits your company provides, such as accident and health coverage, group term life insurance, and tuition assistance. The costs of these benefits, assuming they are reasonable, are also deductible business expenses.
You should keep in mind that employing family members means they must actually work in the business for compensation that is reasonable for the type of work they are performing. Also, be aware that the tax status of any retirement account or plan vehicle (and there are many types) is strictly governed by regulations that cover both employer and employee. Nonetheless, putting family members on the payroll can offer clear financial and tax benefits. Remember, always consult with your tax professional about your own situation before making any decisions.