Strategies for Small Businesses and Sole Proprietors to Save Money on Taxes -Part 5 of 10
If you’re a small business owner, hiring family members can be more than just convenient—it’s a smart, tax-friendly move that puts more of your hard-earned money back into the business. Whether it’s your kids, spouse, or even your parents, bringing family on board lets you shift income within the household, potentially reducing your tax burden. Plus, you can give them valuable work experience and financial benefits while building a more family-focused business. But there’s a catch: the IRS has strict rules on these arrangements, so to make the most of this strategy, you’ll need to keep everything legit and well-documented.
Here’s the lowdown on the tax perks, the best family members to hire, and how to make sure everything’s by the book.
1. Why Bother Hiring Family Members?
Hiring family members can pay off in a few key ways:
- Income Shifting: By shifting income to family members in lower tax brackets, you reduce the total tax hit on your household. For instance, your kid’s income will likely be taxed at a lower rate than your own.
- Payroll Tax Savings: If your kids are under 18, you don’t have to pay Social Security and Medicare taxes on their wages in certain business structures. A solid payroll tax savings compared to hiring outside help.
- Tax-Deductible Wages: Wages paid to family members are typically deductible as legitimate business expenses, lowering your taxable income.
- Retirement Savings: Help family members build up retirement savings, taking advantage of tax-free or tax-deferred growth.
Of course, the IRS is all for this—as long as the work is legitimate, the wages are reasonable, and you’re following proper documentation.
2. Hiring Your Kids: A Win-Win
Hiring your kids is one of the most tax-efficient moves you can make, especially if they’re under 18. Here’s why:
- Payroll Tax Exemption: In a sole proprietorship or partnership where both partners are parents, wages to kids under 18 are exempt from Social Security and Medicare taxes. If they’re under 21, they’re also off the hook for Federal Unemployment Tax (FUTA).
- Standard Deduction: If your kid’s income stays below the standard deduction (currently $13,850 for 2023), they may not owe any federal income tax on their earnings, letting them keep it all.
- Roth IRA Contributions: Your child can contribute to a Roth IRA with their income, allowing for tax-free growth. A great head start on retirement savings they won’t appreciate now but will thank you for later.
3. Hiring Your Spouse: More Than Just Extra Hands
Hiring your spouse can be a big help tax-wise, especially if they’re doing real work in the business:
- Health Insurance: You can offer your spouse health insurance as an employee, making the premiums a deductible business expense. With family coverage, you could extend it to cover yourself and dependents, too.
- Retirement Contributions: Like other employees, your spouse can participate in retirement plans such as a 401(k), reducing their taxable income and helping build up retirement savings.
- Other Payroll Benefits: From life insurance to educational assistance, your spouse can qualify for employee perks that stay deductible for the business.
4. Other Family Members
Your family doesn’t stop with your spouse and kids. Parents, siblings, or in-laws might also bring value to your business and offer tax-saving opportunities. Just make sure the work they do is essential to the business and that their wages are reasonable.
Example: Hiring a retired parent to help with customer service or other support tasks lets them earn extra income without dipping into retirement savings, while you get a business expense deduction.
5. Documentation: The IRS is Watching
When hiring family members, keeping clean documentation is essential. Here’s how:
- Set Clear Job Descriptions: Each family member should have a formal job description that outlines their duties. It’s not just for the IRS—it helps keep everyone accountable.
- Pay Reasonable Wages: Don’t pay your kid $50 an hour to answer phones. Stick to wages that align with the type of work they’re doing.
- Keep Payroll Records: Track everything as you would for any other employee. Maintain timecards, pay stubs, and tax forms, and file W-2s when applicable.
- Follow Labor Laws: Just because they’re family doesn’t exempt you from child labor laws. Make sure hours, duties, and working conditions comply, especially for minors.
6. Putting It Into Action: Steps to Hiring Family Members
Ready to bring your family on board? Here’s a quick roadmap:
- Identify the Need: Make sure you actually have a role to fill.
- Create Job Descriptions: Outline their responsibilities and required hours.
- Research Wages: Pay what you’d pay an outside hire for the same work.
- Set Up Payroll: Treat them like any other employee for payroll and taxes.
- Keep Track: Log their hours, duties, and pay.
- Consult a Tax Pro: A tax advisor can ensure you’re meeting IRS requirements and maximizing the tax benefits.
Conclusion
Hiring family members is a tax-smart strategy with real financial benefits for your small business. Just be sure the roles are legitimate, wages are reasonable, and you’re following the IRS rules. With the right setup, you can keep more money in the family, provide real-world experience, and give everyone a boost toward their own financial goals. And if you’re doing it right, it just might make tax season a little easier on your wallet.
