Hire your children & reduce your taxes

I advised a client today about the tax implications of hiring his children in his wife's unincorporated business. Here are the basics according to IRS Publication 15 (Circular E) Employer's Tax Guide (pg. 12):

• Children under the age of 18 are not subject to payroll taxes (Social Security & Medicare) on wages paid to them by their parent's unincorporated business.
• Children age 18 to 21 are not subject to federal unemployment taxes (FUTA) on wages paid to them by their parent's unincorporated business.
• The two rules above apply to a business run as sole proprietorship or as a partnership in which the only partners are the two parents.
• The rules above DO NOT apply to a corporation of any sort, even if the only shareholders of the corporation are the parents; however, our interpretation is that these rules DO apply to LLCs that are taxed as sole proprietorships or partnerships.

If you choose to use this strategy, please note these two points:

• This strategy only reduces payroll taxes & federal unemployment tax so your children might still be subjected to federal income tax when using it. Even so, this strategy can shift income from your higher tax bracket into your child's lower tax bracket and still provide an overall reduction in your tax burden.
• Your children need to provide legitimate services to your business for this strategy to stand up to audit. The services need not be highly-skilled, but they should be documented in a consistent manner.