Are corporation owners stuck with paying payroll taxes for their kids? Or is there another way around it?
Teaching children basic life skills is a must for every parent. Business owners who employ their children get to teach their children about entrepreneurship, how to develop good work ethics, and even get child and the business a tax break.
The amount children can be paid tax-free is now up to $12,000 per child. Business owners do not have to pay payroll taxes for employing their kids if their business is a sole-proprietorship, a single-member LLC taxed as a disregarded entity, or an LLC taxed as a partnership and owned solely by the business owner and his or her spouse.
But if the business is a corporation … the IRS rules clearly state that business owners MUST pay payroll taxes on income given to their employed children. Are corporation owners stuck with paying payroll taxes for their kids? Or is there another way around it?
How to Work Around the Corporation’s Payroll Tax for Children
If a business is set up as a partnership with other non-parent partners, or as an S or a C corporation, owners must withhold payroll taxes when employing their kids.
However, almost nobody is aware that there is a legal strategy to avoid payroll taxes when employing your kids. Instead of paying children directly from the S Corporation, they can be paid through a “family management company” set up as a Sole Proprietorship.
Owned by the business owner or his or her spouse, the purpose of the family management company is to support the operations of the Corporation by scheduling and monitoring the jobs of the business owner’s children, as well as all the bookkeeping and documentation necessary to keep the jobs within IRS standards.
The Corporation pays the family management company a fee for the monitoring and scheduling services of the business owner’s kids. Since the children are employed under the family management company, they are not under the corporate payroll.
The family management company falls under the IRS exemption where payroll taxes do not have to be withheld since it is a Sole Proprietorship. In effect, the business owners have found a way to pay their child $12,000 tax-free following IRS rules.
Is this Tax Strategy Worth the Effort?
Setting up a separate family management company just to pay the business owner’s children may seem a little complex at first, but it is just as complex as having to withhold and submit payroll tax. If the business owner employs several children, the cost savings can be significant.
The tax strategy may be aggressive but it is perfectly legal when it is done right. The facts are simply changed to match what the IRS code allows.
If the Internal Revenue Service audits the family management company, the business owner must show that the company actually did the scheduling and document the children’s work. You must do this in any business in which you pay your children. The better the records and documentation is kept of the time worked, the easier any audit would be.
The bottom line is that when children are placed on the payroll, the income of business owners from their higher tax bracket is diverted to their children’s lower tax bracket. If done right, it further reduces taxes with a business deduction for the wages paid.
The family management company strategy may save business owners thousands of dollars in taxes and build stronger families. Children develop a work ethic and learn the value of money. They can pay for their own expenses where appropriate, save for their college tuition, and even pay their own way on family vacations.
Tax courts agree that individuals have the right to strategically use the tax code to their advantage and lower their tax burden. If everything is carefully documented, there is nothing to fear when using legitimate tax strategies.