The Truth about hiring your children as Employees
For sole-proprietors, there is a tremendous tax advantage for those who hire their own children as employees. For 2001, a dependent child can earn as much as $4,550 without having to pay any taxes. A "dependent child" is someone who is under the age of 19 or a student under the age of 24.
1. The dependent child is paid $4,000 in wages.
2. The parents receive a deduction for that full amount.
3. Assume the business income is $25,000
4. The amount would then be reduced by $4,000 bringing it to only $21,000.
5. The tax liability is also reduced by $1,122. (This assumes this was the only income for the family and the household included two parents and two dependent children).
At first glance this seems very good. However, the paperwork gets more complicated. In order to legally hire your dependent children as employees, you must follow the rules. The following information is for sole proprietors who have only their dependant children as employees:
1. According to the Attorney General, in the state of Massachusetts, a child under the age of 16 must obtain a work permit from their local school superintendent. This can get more complicated for home-schooling families who use apprenticeships to teach their children as young as 11 years old. No matter what state you are in, it would be a good idea to check with Home School Legal Defense Association (for home-schoolers) or your local school board to find out exactly what the child labor laws are for your state. You can even check out the following two websites for more information:
2. Even if you have no other employees, you would still need to obtain a Federal Employer Identification Number. You can do this by filing form SS-4 with the IRS. It would be a good idea to make it clear, on the form, that you are only hiring your dependent children.
3. Annually, you would need to file the following forms:
a. Form 940 -FUTA - annual tax return for Employers
FUTA tax is required for any wages above $7,000 paid to each employee. In the case of dependent children, the FUTA tax is not required. On Part 2, line 2, simply state "Family employment - dependent child/children". This is exempt from FUTA. (If the child is only being paid $4,000, the FUTA tax would not apply anyway.)
b. Form 941 - Employers Quarterly Federal Tax return
This form is for employers who withhold income taxes, social security and Medicare taxes. You may not need to file this form, check with your tax advisor.
You must furnish a copy of the W-2 for each of your employee -children. This must be given to them no later than January 31. Copy A must also be sent to the Social Security Administration by the last day of February. Be certain that your children have filled out form W-4 (Employees withholding allowance certificate) and claimed "exempt".
d. W-3 - Summary Transmittal
This is to be sent, along with the W-2's, to the Social Security Administration.
e. In Massachusetts, an employer is required to file form WR-1, Employers' Quarterly Report of Wages Paid. If you are not a resident of Massachusetts, go to your state's website for information or check with your tax advisor.
* Parents who hire their dependent children as employees are not required to pay Federal unemployment taxes for them (FUTA) nor are they required to obtain Unemployment compensation insurance. Children under the age of 18 are not required to pay Social Security taxes.
4. Some helpful ideas:
If your child is paid $4,000, simply pay them by check and have them open a bank account. Have them use this money for clothing, books, food, entertainment, etc. This is a legal way to have an incredible deduction without affecting your household needs. In other words, the wages should not be used for frivolous purchases but practical needs.
Be certain to keep excellent records - How many hours worked, what days, the exact dates, what did the child do, etc. Follow closely to the rules of the child labor laws.
The deduction is certainly worth the effort. If you'd rather not deal with all the paperwork, hire a tax professional - their fee is deductible!
~ Mrs. Sharon White, CTP Copyright 2002 Puritan Tax