“Allowance” and other financial aid you extend to your children, grandchildren, or even parents is a deductible business expense if you pay them to perform bona fide work for your business and pay them reasonable compensation for that work. Of course, at that point, it isn’t allowance. It’s wages. If you’re hiring your kids, they might even learn not to treat you like “The First National Bank of Mom and Dad.”
Your child can earn up to the standard deduction for a single taxpayer, $6,100, before owing any income tax. The next $8,950 is only taxed at 10%. Earned income isn’t subject to the “kiddie tax” for children under 19 or dependent full-time students under age 24. Other family employees pay tax at regular income tax rates.
According to the Tax Court, children as young as 7, may receive a wage. However, the family employee’s work must be directly related to your business. You must also pay your employee a reasonable wage for their age and the service they perform. The amounts should be similar to the amounts paid by other similar businesses under similar circumstance, but can be adjusted for age and experience. There is a federal minimum wage and even family employees are subject to receive it.
To verify your deduction and audit-proof your return, keep a timesheet showing the dates, hours, and services performed. Pay your child by check, and deposit the check in an account in the child’s name. This can be a Roth IRA, Section 529 college savings plan, or custodial account. You can’t use custodial assets for your obligations of parental support; however, parental support doesn’t include “extras” like private or parochial school tuition, summer camps, and similar expenses.
If your business is taxed as a proprietorship, you don’t owe Social Security or Medicare taxes on your child’s wages until they reach age 18. You don’t owe unemployment tax until they reach age 21. The same rule applies if your business is taxed as a partnership and you and your spouse own all partnership interests.
Hiring family members to help work in your business also lets you establish employee benefit programs such as a medical expense reimbursement plan, education assistance plan, and retirement plans. Both the family member and the business benefit by paying these wages. The business will get an added tax benefit whereas the family member receives a higher “allowance” by being on the payroll.
If you have any questions regarding the benefits of family employees and would like to learn how to implement this within your business, please do not hesitate to contact us