Learn How to Minimize Your Family's Tax Burden

Parents: Did you know that you can hire your kids in your small business and reduce your taxes?

If you own your own business, one of the greatest tax saving strategies you have available to you is the ability to hire your children. Here are a few ways that hiring your kids can save you in taxes:

1. You get a tax deduction for the wages you pay your kids, which reduces your taxable income

2. By paying your children, you are effectively transfering income from your higher tax bracket to your childrens' lower tax bracket

3. Business expenses - including wages paid to your kids - reduce your business income, which in turn reduces your self employment tax

4. Your kids may not owe any tax on the amount you pay them, depending on how much they earn and whether you claim them as a dependent or not (in 2009, dependent children can earn up to $5,450 before they will owe any income tax)

5. Kids who have earned income can open a Roth or Traditional IRA, giving them a jump start on their retirement savings

You might also want to consider this strategy if your children have their own business. Instead of the kids owning the business, you could minimize your family's total tax liability by having the parents own the business and hiring the kids and paying them a wage.

Why would it matter who owns the business? Well, if you are self employed, you have to pay self employment tax on your net earning over $400. This rule applies to both adults and children, so there is no advantage to being a kid when you're self employed. However, kids have a huge advantage if they earn wages paid from an employer. Why? Well, kids don't have to pay taxes on the first $5,450 of earned income, even if they are claimed as a dependent on their parents' tax return.

Here's an example:

Let's assume Teddy, how is 14 years old, has a web design business. In 2009, he expects to earn $5,000 from this business after all of his expenses.

If Teddy is the owner, he is considered self employed and he will have to pay 15.3% in self employment tax on this income. Assuming this is his only income, he won't owe any federal income tax because his total earnings are less than the standard deduction amount ($5,700 in 2009), but he will still have to pay self employment tax on the net profit. Teddy's total tax in this example will be $765.

Now let's assume that Teddy's dad is the owner of the business and he hires Teddy to do the work. Teddy still earns $5,000, but he is his dad's employee instead of being self employed, therefore he doesn't have to pay self employment tax. Teddy's dad will report the $5,000 in income on his tax return, but he gets to deduct the $5,000 he pays Teddy to work in the business, so dad won't owe any tax on this income. In addition, because Teddy is under 18, Teddy's dad doesn't have to pay payroll taxes on him. Finally, because Teddy earned less than the standard deduction, his total tax liability will be zero.

In this example, the family's total tax savings by having the business in the father's name and having the child as an employee instead of the owner is $765.

Parents: want to learn how to minimize your family's taxes? If you have a small business, or if your child has their own business, you'll want to learn how to hire your children to help minimize your family's tax burden.

Child Entrepreneurs: Taxes Could Be Your Biggest Expense

Kids who start their own business do so because they want extra money... some have specific goals such as buying a car, others just want extra spending money. I'm going to go out on a limb here and assume that the last thing kids are thinking about when they start a business is the taxes they will owe on any profits they earn.

However, as self employed people, taxes could be one of their biggest expenses. Self employed people are subject not only to federal income taxes, but to self employment taxes as well. As a result, this can be the biggest expense for a self employed person, and can be quite a shock if you're not prepared for it.

What is self employment tax? Basically, self employment tax represents Social Security and Medicare taxes for people who work for themselves. This tax is used to fund our Social Security program, including retirement benefits, disability benefits and survivor benefits.

Self employment tax is similar to the payroll taxes withheld from the pay of most employees. The biggest difference is that as a business owner, you are required to pay both the employee and the employer's share of the Social Security and Medicare taxes. So while employees of a company pay 7.65%, self employed people pay 15.3% in Social Security and Medicare taxes.

Even worse, this tax is on top of your regular income tax. For example, if you are in the 15% tax bracket, your taxes on your net profit could be over 30% (15% federal tax plus 15.3% self employment tax).

When is self employment tax due? Our tax system is a pay-as-you-go, which means you are required to pay taxes on your income as you earn that income. If you are an employee of a company, you do this through withholding. If you are self employed, you do this through estimated tax payments.

Generally, you have to make estimated tax payments if you expect to owe at least $1,000 in tax for the current tax year, after subtracting your withholding and tax credits. Estimated tax payments are due on April 15, June 15, September 15 and January 15 of each year (or the next day if the 15th falls on a weekend or holiday). Failing to make estimated tax payments on time could result in a penalty even if you are due a refund when you file your tax return.

It's a good idea to set aside 20-30% of your profits (depending on how much other income you have and what tax bracket you fall into) even if you aren't required to make estimated tax payments to make sure you have the money to pay your taxes when you file your tax return.

Children And Taxes: When Kids Are Required To File A Tax Return

As kids get older, it is inevitable that they will want more money to buy things like clothes, music, a new car, etc. Many kids will get a job or even start their own company to meet their demand for more "stuff".

While most kids don't earn enough money to worry about filing a tax return, some will be required to file based on the type and amount of income they earn. How do you know when your child is required to file a tax return?

In general, children who are dependents (claimed on someone else's tax return) must file a tax return if:

- they have earned income of $5,700 or higher (this is the standard deduction amount for 2009, the amount for 2008 was $5,450)
- they have unearned income (investment income) of $950 in 2009 ($900 in 2008)
- they have gross income (both earned and unearned) in excess of the larger of $950 or their earned income plus $300.

The most popular reason kids would need to file a tax return is because they had earned income from a part time job or because they are lucky enough to have investments in their own name, as described in the above rules. However, the following children may also need to file a tax return:

- those who have earned income and who received advanced earned income credit payments from his or her employer,
- kids who had wages of $108.28 or more from a church, that is exempt from employer Social Security and Medicare taxes, or
- kids who had net earnings from self employment or their own business of at least $400.

Here's an example of a teenager who would be required to file a tax return: Tommy is 14 and his parents claim him as a dependent on their tax return. In 2008, Tommy started a lawn mowing business and earned $750, after paying for gasoline and other expenses. Because he is considered self employed and earned more than $400, Tommy is required to file a tax return. On the flip side, if Tommy had worked for someone else as an employee and only earned $750, he would not have been required to file a tax return.
Filing your child's tax return:

Kids who only have unearned income (from investments, for example) can either file their own tax return or their parents can claim the income on their tax return.

If the child is required to file because she has earned income from an employer, or if she has a business of her own, then she will need to file her own tax return. In addition, children with their own businesses will need to complete Schedule C - Profit or Loss From Business and Schedule SE - Self Employment Tax and attach these to their income tax return.


Parents: want to learn how to minimize your family's taxes? If you have a small business, or if your child has their own business, you'll want to learn how to hire your children to help minimize your family's tax burden.

Recommended Resources:

• Child Entrepreneurs: Don't Forget About Taxes
• Tax Benefits For Hiring Your Children
• Kids and Money on Zimbio
• Five Tips To Minimize Your Family's Taxes
• Is Your Child Required To File A Tax Return?