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Keep it in the family
Hiring your child creates the beneficial effect of transferring income from you to your child. You get a tax deduction at your own tax bracket, and your kid takes the income in a lower tax bracket. (Make sure you follow all child labor laws. See www.twc.state.tx.us/ui/lablaw/cllsum.html for a summary.)
In fact, the child’s income might not be taxed at all. A parent can pay up to $4,600 in 2004, and the child will not owe any tax if the child has no other income. (Many people are aware that income of a child under the age of 14 is taxed at the parents’ tax rate. That rule applies only to investment
income, not earned income; thus, the wages paid a child will be taxed at the child’s rate, not the parents’ rate, even if the child
is younger than 14.)
The job needs to be a real job with real duties, and you must pay
a reasonable wage for that type of work. Paying your daughter
$50 an hour to run errands will make you vulnerable should the IRS decide to look at your records.
Another advantage—the child can make a contribution to a retirement account (a Roth IRA is likely the best choice), because she has earned income.
If you hire your child as an employee, there are some payroll tax breaks. No Social Security or Medicare tax needs to be paid or withheld if the child is under 18, and no federal or Texas unemployment taxes needs to be paid if the child is under 21. Those tax breaks apply if you operate as a sole proprietorship or as a partnership in which the only partners are the child’s parents. Federal income tax withholding rules still apply, however.
You will need to prepare a Form W-2 for the child at the end of the year. In addition, you will need to file the quarterly federal payroll report, Form 941, even if there is no tax withheld that needs to be sent in to the IRS. You will also need to apply for an Employer Identification Number using Form SS-4. There is no cost to get the number.
—Debbie Webb, MS, CPA, of Thompson,
Derrig & Craig in Bryan/College Station
Photo © Photodisc.
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