Hire Your Kids to Lower Your Taxes

If you own a business, hiring your children may be one one of the smartest business decisions you can make this year.

If you are a self-employed or have a partnership with you and your spouse as the only partners, you can save on payroll taxes if your children are under 18 and you hire them to do work in your business you would have to pay others to do anyway.

In such unincorporated businesses, your minor children are exempt from federal FICA and FUTA taxes. Usually, they are also exempt from state unemployment and disability taxes.

There is no limit on how much your children can earn, but any wages have to be reasonable and legitimate pay for work performed. This requires careful planning and documentation. More about this later.

Your children's wages may also be taxed at a lower income tax rate than you would pay on your own personal federal and state tax returns.

The lowest federal tax rate for individuals is currently 10%. Your dependent children can make up to $5,150 in earned income during 2007 without owing any federal income tax. If these children earn enough to file a federal return, they can earn up to $7,825 in taxable wages and pay only 10% federal taxes.

All wages you pay to others, including your children, are deductible from your gross business income, reducing your own tax liability. This can be a real tax advantage for parents subject to self-employment taxes.

Good record keeping is essential. First, you should have a written description of work your child is expected to perform. Also, fill out a W-4 form for each child and keep it on file.

Have your child keep a time card of all hours worked.

Write regular paychecks, as you would for any employee, rather than paying in cash, like an allowance, or settling up once or twice a year.

Make sure the hourly rate is reasonable for the work performed. You can certainly pay above the federal or state minimum wage rate, but $50.00 an hour for cleaning your home office or performing clerical tasks probably won't survive an audit. A good rule of thumb is to pay what it would cost to have similar work performed by an employee other than a family member.