How to lower your taxes while funding you kid’s education!

By Jeffrey Brooks, CPA, CFP, MBA for Jbrooks Wealth Advisors, PC, a Professional CPA and CFP Firm 602-687-9900 x101. Every taxpayer situation is unique so do not rely on this article as correct for your situation but contact your professional CPA or tax professional.

Have you though about shifting a small portion of your Income to your child or children?

Employing family members who are in a lower tax bracket than the business owner (usually children
or grandchildren) can shift taxable income to them, thus reducing the family’s tax burden. The IRS is well
aware of this technique and is likely to examine any family employment arrangement to
make sure the compensation is reasonable.

If it is unreasonable relative to the services performed,

it may be recast as income to the business owner.

I recommend that my clients have their children sign an application for employment, children sign off on a job description,AND require that their children submit regular timesheets.

What are the advantages of Hiring Children in the Family Business?

Income Shifting!

The business owner deducts reasonable compensation paid to the child and the child receives and reports earned income from compensation
which is often taxed at a lower rate than the business income would have been. A child claimed as a dependent is entitled to a
standard deduction equal to the greater of $950 or earned income plus $300 (not to exceed $5,950) for 2012. (Rev. Proc. 2011-52)

Fringe Benefits

The child-employee may be eligible to participate in employer sponsored fringe benefits such as health and disability insurance or employer-provided vehicles for business travel.

Payroll Tax Exemption

Wages and compensation paid by a sole proprietorship (or partnership, if the parents of the child are the only partners) to the proprietor’s
(or partner’s) child who is under age 18 are exempt from FICA payroll taxes. Similarly, this compensation is exempt from FUTA tax if the child of the proprietor (or partner) is under age 21.

However, federal income tax withholding will apply unless the child can claim an exemption from withholding.

Individual Retirement Account Opportunity

Earned income paid to the child enables the child to fund an IRA contribution [up to the lesser of $5,000 (for 2012) or 100% of earned
income] [IRC §219(b)(5)(A)]. Usually, the child will qualify to make a deductible contribution to a traditional IRA since he is either not
covered by an employer retirement plan or his income is beneath a certain level. A Roth IRA, which potentially allows all earnings to be
tax-free, may be attractive due to the child’s long horizon for saving. Compounding income either tax-deferred or tax-free for many years
is a powerful way to build wealth.

Example: Sally hires her 11-year-old son, Mark, to work in the stockroom of her retail business which operates as a sole proprietorship.
The employees earn $10 per hour; Mark is paid $6 per hour based on the types of services he is able to perform. In 2012, Mark earned $1,700 in wages from the retail business. . His only other income is $425 of dividends. Mark avoids paying federal income tax on the entire $1,700 of wages since he is entitled to a $2,000 standard deduction (the lesser of $5,950 or $300 plus his earned income, if it exceeds $950), and Sally’s business is entitled to a $1,700 deduction for the wages paid to Tim. In addition, only $125 ($425 – 300) of Mark’s unearned income is taxed, and, for 2012, it is taxed at a 0% dividend tax rate—the kiddie tax (which taxes unearned income of children at their parents’ rate) does not apply because unearned income is less than $1,900 Also, the wages are exempt from FICA and FUTA tax.

The kiddie tax rules apply to children (1) under age 18, (2) age 18 if their earned income doesn’t exceed one-half of the amount of their support and (3) age 19–23 who are full-time students if their earned income doesn’t exceed one-half of the amount of their support [IRC §1(g)(2)(A)]. Employing a child is a particularly timely strategy for older children whose unearned income will be subject to the kiddie tax.

I hope this article is helpful to you!!

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About Jeffrey Brooks

Jeffrey Brooks, CPA, CFP, MBA since 1976 has specialized in helping clients save significant taxes, help businesses increase their cash flow, revenues and profits while increasing their control and satisfaction. Jeff and his accounting firm sincerely cares about the happiness of his clients.

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JBrooks Wealth Advisors, PC.

Certified Public Accountant
Address: 4647 N 32nd Street, Suite B245
Phoenix, Arizona 85018
Phone: 602-292-2009