A reader recently asked how hiring their children in their business could help save on income taxes.  Here’s an example:

In 2006, you could pay your child up to $5,150 (the standard deduction amount) without either of you incurring a tax liability. Suppose you’re in the 28 percent tax bracket and you pay your 15-year-old son (Junior) $5,000 over the course of a year to help package and ship items in your eBay business.

You get a business deduction for the wages paid to Junior, saving you $1,400 (28% of $5,000). If you’re a sole proprietor, you save even more in taxes because this reduces the amount of profit that is subject to self employment taxes (15.3% of $5,000 = an additional tax savings of $765).

Since your son’s earnings are less the standard deduction, he does not owe income taxes on his earnings. Even if you paid Junior more than the standard deduction, you would still save taxes. Since Junior is most likely in a lower tax bracket, his earnings would be taxed at 10 percent or 15 percent rather than 28 percent that you would pay on this income. This is called income shifting.

In addition, because Junior is under age 18, you do not have to pay Social Security, Medicare or Unemployment tax on him, like you would with a regular employee.

You could take this strategy even further by opening an IRA for your son thereby sheltering even more income from taxes.

This is a great strategy if your children are old enough and are interested in working in your business. The only thing to watch is that your children have to actually do legitimate work in the business, and you have to pay them a reasonable wage for the work they do. You can’t pay them $5,000 a year to do household chores or just to empty the garbage can (even if it’s your home office trash can!).

Recommended Resources:
Hire Your Kids in Your Small Business: A Step by Step Guide

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