- Discover information about the higher standard deduction for 2022.
- Learn about IRA options for your kids.
- Find out how self-employed parents can benefit from hiring their children.
- Learn about the tax benefits of employing your children – for both parents and children.
Summer is almost here. Are you looking for summer employment for your children? There are plenty of perks beyond pocket money that you and your children should know about. For instance, the standard deduction for single individuals increased from $12,550 in 2021 to $12,950 in 2022. This means your child can now make up to $12,950 from working without paying any income tax on their earnings.
In addition, they can contribute the lesser of $6,000 or their earned income to an IRA. If they contribute to a traditional IRA, they could earn up to $18,950 tax-free, by combining the standard deduction and the maximum allowed deductible contribution to an IRA for 2022 of $6,000. However, looking forward to the future, a Roth IRA with its tax-free accumulation and distributions I would offer- may be a better choice. However, the contributions to a Roth IRA are not deductible.
What if your child is reluctant to give up any of their hard-earned money from their summer or regular employment? If you have the financial resources, you could gift them the funds to make the IRA contribution. This will give them a great start and hopefully a continuing incentive to save for retirement.
Perks for Self-Employed Parents
Vacation time is just around the corner and employees are heading out for their summer vacations. If you are self-employed, you might consider offering your own summer employment for children. Why not hire your children to help out in your business? Financially, it makes more sense to keep the family employed rather than hire strangers. Of course, the family member must be suitable for the job.
Rather than helping to support your children with your after-tax dollars, you can instead hire them in your business. Then you can pay them with tax-deductible dollars. Of course, the summer employment for your children must be legitimate. The pay must be commensurate with the hours and the job worked. A reasonable salary paid to a child reduces the self-employment income and tax of the parents (business owners) by shifting income to the child.
Example: Let’s say you are in the 24% tax bracket and own an unincorporated business. You hire your child (who has no investment income) and pay the child $16,000 for the year. You reduce your income by $16,000, which saves you $3,840 of income tax (24% of $16,000). Your child also has a taxable income of $3,050, $16,000 less the $12,950 standard deduction, on which the tax is $305 (10% of $3,050).
If the business is unincorporated and the wages are paid to a child under age 18, the pay will not be subject to FICA (Social Security and Medicare taxes). Why? Employment for FICA tax purposes doesn’t include services performed by a child under the age of 18 while employed by a parent. Thus, the child will not be required to pay the employee’s share of the FICA taxes. Even better – the business won’t have to pay its half either.
Example: Using the same information as the previous example, and assuming your business profits are $130,000, by paying your child $16,000, you not only reduce your self-employment income for income tax purposes, but you also reduce your self-employment tax (HI portion) by $429 (2.9% of $16,000 times the SE factor of 92.35%).
But if your net profits for the year were less than the maximum SE income ($147,000 for 2022) that is subject to Social Security tax, then the savings would include the 12.4% Social Security portion in addition to the 2.9% HI portion.
A similar but more liberal exemption applies for FUTA. This exempts from federal unemployment tax the 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 or her parents.
However, the exemptions do not apply to businesses that are incorporated or a partnership that includes non-parent partners. Even so, there's no extra cost to your business if you're paying a child for work that you would pay someone else to do anyway.
Summer Employment for Children = Retirement Plan Savings
Let’s refer back to our original example. If the child had made a traditional IRA contribution of $6,000 the taxable income and the tax would be zero. So, it might be appropriate to make a Roth IRA contribution instead. Since the child has so many years before retirement, the future tax-free retirement benefits will far outweigh the current $305 savings.
Of course, some children will not be thinking about retirement at their young age. They may object to contributing to an IRA. If that is the case, perhaps you as the parent, or even the grandparents, can make a gift of the IRA contribution. This contribution can grow to big bucks by the time the child reaches retirement age.
Have questions related to your child’s employment or hiring your child in your business? Call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations to discuss your situation.