Gregory S. DuPont
It Can Pay to Employ Family Members
Business owners may be able to substantially reduce their overall income tax burden by employing family members. Income tax savings can be obtained through a variety of deductions, exemptions, credits, and strategies. These benefits may be available regardless of a business’s structure (corporation, partnership, or sole proprietorship).
Here is a brief overview of some of the main areas worth considering for possible tax saving opportunities:
Tax Deductions for Compensation. Employers are entitled to tax deductions for compensation paid to a spouse, parent, or child, provided the following requirements are met: 1) income must be earned, not a gift ¾ that is, it must be paid in exchange for actual services; and 2) compensation must be set at the prevailing rate for a comparable position. In cases where the employee is a child, the compensation should be formally recognized as such, and paid directly to the child.
Savings from Putting a Child on the Payroll. Although family members are generally subject to Federal income taxes, children under age 18 are exempt from FICA (Federal Insurance Contributions Act) and FUTA (Federal Unemployment Tax Act) taxes. In some cases, business owners may be able to reduce their own FICA tax by shifting part of their income to a child. Since a child’s ability to use the standard deduction on unearned income is limited, putting the child on the payroll¾thus, providing him or her with earned income¾may allow the full use of the child’s standard deduction. In addition, putting a child under age 14 on the payroll may reduce or eliminate the so-called “kiddie tax” on unearned income.
Employee Benefits at Low or No Tax Cost. Other family members may also benefit from tax savings, particularly through the use of employee benefit programs. Group life insurance, health and accident insurance, interest-free loans, tuition payments, and meals and lodging provided for the employer’s convenience, may be available at low or no tax cost. By offering an employee health plan, and employing a spouse, a business owner may, in effect, secure a deduction for his or her own coverage.
Family members may also be entitled to benefits from company retirement plans. In some cases, the minimum pension may even exceed the employee’s average annual compensation. In addition, the business may be able to take a tax deduction for contributions to the plan. Family members may also be eligible to contribute to Individual Retirement Arrangements (IRAs) and, in some cases, the contributions may be tax deductible. Even a child may be able to create an IRA, provided certain requirements are met.
Other Tax-Saving Opportunities. A variety of other tax savings are also possible. For example, the Internal Revenue Service (IRS) provides a child care tax credit or exclusion for dependent care expenses. Putting a caretaking spouse on the payroll can help offset those expenses. Another tax advantage can occur through bracket-shifting. With bracket-shifting, a portion of a business owner’s earnings, that would have been taxed at the owner’s rate, can be paid instead to a family member who is in a lower tax bracket.
Additional tax savings can be achieved by putting family members (with appropriate experience) on the board of directors. Since directors’ fees are classified as self-employment income, this compensation can form the basis for a Keogh or IRA contribution. Also, directors’ fees may escape self-employment taxes if the directors’ income from other sources exceeds the Social Security wage base in the year the fees are earned.
These opportunities may help business owners realize significant tax savings. Other tax-saving strategies may also be possible. As with all tax matters, it is best to consult a qualified tax professional to determine eligibility for specific benefits, and to obtain guidance in developing the most effective tax plan for a particular situation.