ELITE ADVISOR BEST PRACTICES
Helping Clients Save on Taxes by Hiring Their Kids - Part Two
How it cuts clients’ income taxes
By Glenn Demby
- Clients who own small businesses can cut their taxes substantially by hiring their dependent children.
- The arrangement saves taxes by shifting your clients’ business earnings, which are taxed at a high rate, to their kids’ personal earnings, which are taxed at a lower rate.
- But for the arrangement to be legal, the children must work for the clients under “bona fide” employment arrangements acceptable to the IRS.
- Bracket-shifting for bona fide employment works even for a child subject to the “kiddie tax” (which causes the child’s investment income in excess of $2,000 for 2014 to be taxed at the parent’s marginal rate).
As many advisors are aware, you’re allowed to deduct reasonable wages that you pay your employees as an ordinary and necessary business expense. This rule applies to wages you pay to employees who happen to be your minor, dependent children, as long as you can show that their employment is “bona fide.” In Part One of this series we looked at what constitutes bona fide employment. Now let’s look more deeply into the income tax savings your clients (and you) can accrue by being able to deduct kids’ wages.
Simply stated, hiring minor kids via bona fide employment arrangements cuts the business owners’ taxes by shifting their own business earnings, which are taxed at a high rate, to kids’ personal earnings, which are taxed at a lower rate (or maybe not taxed at all). Let’s use the following example to illustrate the resulting tax benefits.
Remember that to realize these tax savings, the work arrangement your clients make with their minor children must be bona fide employment. The IRS is very strict about applying this rule. See Part One of this series to see what constitutes “bona fide employment” and to find out about the seven things you can tell your clients to do to ensure that their employment arrangements with their own minor children stand up to IRS scrutiny.
This article was adapted with permission from MurrayBradfordTaxInstitute.com, a site dedicated to helping self-employed taxpayers and one-owner businesses save on taxes.