One of the deductions that some home business owners can receive come tax time is one that comes from paying their children wages. When you pay your child wages, it can be deducted from your income taxes, and your child can even avoid the kiddie tax (which is most often levied on investment income for children) if you do things right. And, because your child will be making earned income, it’s even possible for him or her to open an IRA and start saving for retirement.
If you want to get a tax deduction for paying your child wages, you need to make sure everything is above board. This means that you have to be scrupulous about your practices when hiring your child to work for you. Some things to keep in mind as you pay your child wages include:
- Your child should be at least six years old.
- Work done must be related to your home business, or to your rental property.
- The child must actually perform the work.
- You must pay wages to the child. One way to do this is to write a check from your business account to the child. A joint savings or checking account  with your child can then be the recipient of the money.
- Compensation must be reasonable. No paying your child $1,000 a week to spend 1/2 an hour a day emptying the trash bin and helping you with filing. Establish a reasonable hourly wage, or a reasonable salary.
- Keep in mind that your child’s tax rate  will be his or her lower income tax rate. If you keep wages to under the standard deduction ($5,800 for 2011), your child won’t owe any income tax at all.
- It might be wise to create an employment contract with your child, and keep it for documentation purposes.
As you can see, it is important to make sure that you set up things up, especially on paper, in a way that shows that you are truly hiring your child, and not just looking for a tax break for paying an allowance .
What About Payroll Taxes?
The good news is that for many home businesses, it is possible to gain an exemption from payroll taxes when you employ your child who is under 18. However, that exemption only applies in certain cases. You want to make sure you are observing the proper tax laws if you want to avoid penalties down the road.
Understand, though, that your home business will need to be unincorporated if you want to avoid FICA taxes. A child under 18 will not have to pay FICA if he or she works for your sole proprietorship, or if the partnership consists only of the two parents. A child also does not have to pay FUTA (unemployment taxes) if he or she is under 21 and working in those conditions.
You can avoid paying federal payroll taxes on your child who works for you if you are a sole proprietorship. If you are involved in a partnership, you may still need to pay payroll taxes for a child who works for you. Additionally, check the tax regulations in your state to find out whether they are different from federal rules. Before you decide on anything, though, it is a good idea to check with a tax professional — just to make sure you are doing everything properly.
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