Entrepreneur magazine - October 2000
By Joan Szabo
If you employ your children in your business , take
advantage of some important tax benefits available to you. For one
thing, the IRS allows parents to deduct reasonable wages paid to minor
children who work in their businesses .
The main tax benefit is to allow businessowners "to shift income out of
the corporation to the child, who can probably shelter that income from
tax entirely," says Mark Watson, a partner in KPMG's personal financial
planning practice in Washington, DC.
Keep in mind that there are some requirements and guidelines you must
follow to properly qualify for the deduction. For example, it's
important to document the type of work your children do and demonstrate
that it's worth what they're being paid. To determine what's a
reasonable sum, figure out what you are paying other people in your
company doing the same job.
It's also important to draw up a job description for the work your kids
perform and make sure what they are doing is necessary for the business .
Tax experts also recommend putting them on the payroll as you do with
all your employees. You'll also want to keep detailed time records
demonstrating how much they are working, and be sure to complete a W-4
form for each of your children. Children under 18 can earn up to $4,400
this year without owing federal income tax. Along with time sheets, keep
canceled checks or pay stubs.
For sole proprietorships, there's another benefit if you employ your
children—namely, wages paid to a child under age 18 are not subject to
Social Security or Medicare taxes. That means your child is not
responsible for paying FICA taxes on his or her wages, nor are you
required to pay the employer's share of these taxes.
Another perhaps more important tax benefit is the opportunity for
working children to put up to $2,000 of earnings or their total earned
income, whichever is lower, into a Roth IRA each year. One of the
biggest pluses of establishing a Roth IRA comes in the withdrawal of
funds at retirement. With a Roth IRA, there is no deduction for
contributions, but growth is tax-free. Tax-free withdrawals are allowed
after the account has existed for five years and the account holder
reaches age 59.
A Roth IRA represents "a home run" as far as tax planning is concerned,
says Watson. Why? Because the money invested in a Roth IRA is sheltered
from federal taxes through the standard deduction ($4,400). In essence,
children who have earned income are contributing money they haven't paid
federal taxes on, the funds are allowed to grow tax-free, and they can
be withdrawn free of federal taxes. Says Watson: "There aren't many tax
benefits as good as this one."
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