Taxpayer Employing Their Child
By employing a child, the income tax advantages include obtaining a business deduction for a reasonable salary paid to that child and reducing the selfemployment and income taxes of the parents (business owners) by shifting income to the child. Since the salary paid to a child is considered earned income, it is not subject to the “Kiddie Tax” rules that apply to children through age 18 and full-time students ages 19 through 23. The Kiddie Tax won’t apply at all to the 19- through 23-year-old student who has earned income that exceeds one-half of his or her total support, another incentive to employ a child in some situations.
The maximum standard deduction available to the child in 2022 is $12,950 (up from $12,550 in 2021). Therefore, the standard deduction eliminates all tax on up to $12,950 of the child’s compensation.
Example 1: A parent is in the 25% tax bracket and owns an unincorporated business. The parent hires their child (who has no investment income) and pays the child $12,950 for the year. The parent reduces their business income by $12,950, which saves the parent $3,238 of income tax (25% of $12,950), and if subject to SE tax, will also have a tax saving on SE tax. The child has a taxable income of $0, $12,950 less the $12,950standard deduction, resulting in a zero income tax for the child.
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If the business is unincorporated, wages paid to the child under age 18 are not subject to FICA (social security and Medicare taxes). Not only are there significant income tax advantages to employing the child, but the parentemployer may provide the child with fringe benefits, such as group-term life insurance and qualified pension plan contributions.
The child may also make deductible contributions to an IRA for 2022 of the lesser of earned income or $6,000. By combining the standard deduction and the maximum deductible traditional IRA contribution, a child could earn $18,950 of wages and pay no income tax. However, the long-term retirement benefits for the child would favor a Roth IRA.
If the child balks at contributing their hard-earned money to an IRA, the parent, grandparent, or other individual might consider giving the child part or all of the IRA contribution as a gift.