HIRING YOUR CHILD

Summer is here and it is time to consider saving taxes by hiring the kids. If you own a business you can save family income and payroll taxes by putting junior family members on the payroll. You may be able to turn high-taxed income into tax-free or low-taxed income, achieve social security tax savings (depending on how your business is organized) and even make retirement plan contributions for your child. In addition, employment of a child age 18 (or if a full-time student, age 19–23) may be a way to save taxes on the child’s unearned income..

Here are the key considerations.

Turning your income into tax-free or low-taxed income. You can turn some of your income into tax-free or low-taxed income by shifting some of your business earnings to a child as wages for services performed by him or her. In order for your business to deduct the wages as a business expense, the work done by the child must be legitimate and the child’s salary must be reasonable.

For example, suppose a business owner operating as a sole proprietor is in the 35% tax bracket. He hires his 17-year-old daughter to help with office work full-time during the summer and part-time into the fall. She earns $5,700 during the year (and doesn't have earnings from other sources).

The business owner saves $1,995.00 (35% of $5,700) in income taxes at no tax cost to his daughter, who can use her $5,700 standard deduction for 2009 or 2010 to completely shelter her earnings. The business owner could save an additional $1,750 in taxes if he could keep his daughter on the payroll for a longer period and pay her an additional $5,000. She could shelter the additional amount from tax by making a tax-deductible contribution to her own IRA.

Family taxes are cut even if the child’s earnings exceed his or her standard deduction and IRA deduction. That's because the unsheltered earnings will be taxed to the child beginning at a rate of 10%, instead of being taxed at the parent's higher rate.

Keep in mind that bracket-shifting works even if the child is subject to the kiddie tax. The kiddie tax only causes a child’s investment income in excess of $1,900 for 2010 to be taxed at the parent's marginal rate. It has no impact on the child’s wages and other earned income, which can be sheltered by the child’s standard deduction.

The kiddie tax applies to a child who is age 18 or a full-time student age 19 through 23, if the child’s earned income for the year doesn't exceed one-half of his or her support. Thus, employing a child age 18 or a full-time student age 19–23 could also help to avoid the kiddie tax on his or her unearned income.

For children under age 18, there is no earned income escape hatch from the kiddie tax. But in all cases, earned income can be sheltered by the child’s standard and other deductions, as noted above, and earnings in excess of allowable deductions will be taxed at the child’s low brackets.

What about income tax withholding? Your business probably will have to withhold federal income taxes on your child’s wages. Usually, an employee can claim exempt status if he or she had no federal income tax liability for last year, and expects to have none for this year. However, exemption from withholding can't be claimed if (1) the employee's income exceeds $950 for 2009 or 2010, and includes more than $300 of unearned income (such as dividends), and (2) the employee can be claimed as a dependent on someone else's return. Keep in mind that your child probably will get a refund for part or all of the withheld tax when he or she files a return for the year.

Social security tax savings, too. If your business is not incorporated, you can also save some self-employment (i.e., social security) tax dollars by shifting some of your earnings to a child. That's because employment for FICA tax purposes doesn't include services performed by a child under the age of 18 while employed by a parent. For example, let's say a sole proprietor who usually takes $120,000 of earnings from the business pays $5,700 to her 17-year-old child in 2009 or 2010. The sole proprietor's self-employment income would be reduced by $5,700, saving her $165.30 (the 2.9% HI portion of the self-employment tax she would have paid on the $5,700 shifted to her daughter). This doesn't take into account a sole proprietor's income tax deduction for one-half of his or her own social security taxes.

A similar but more liberal exemption applies for FUTA, which exempts earnings paid to a child under age 21 while employed by his or her parent. The FICA and FUTA exemptions also apply if a child is employed by a partnership consisting solely of his parents.

Note that there is no FICA or FUTA exemption for employing a child if your business is incorporated or a partnership that includes non-parent partners. However, there's no extra cost to your business if you're paying a child for work you'd pay someone else to do, anyway.

Keep in mind that some of the rules about employing children (such as the maximum amount they can earn tax-free) change from year to year, and may require your income shifting strategy to change, too.

CAN I AVOID TAX IF SALE PAYMENT GOES TO THE BANK?

Larry, I own a piece of property that I owe about $30,000 to the bank. I paid about $10,000 for the property about 10 years ago. Here is the deal. I have an offer of $30,000 on the property. If I had the buyer pay a note directly off for me, would the sale have to be reported to IRS?

Oscar

Oscar, the payment to the bank would be considered income to you and you would have to pay tax on the gain just like if you received the proceeds. The IRS considers relief of debt (the pay-off of a loan) to be the same as a cash sale.

Larry Kopsa CPA

QUOTE OF THE WEEK

"Hate is like acid. It can damage the vessel in which it is stored as well as destroy the object on which it is poured."
--Ann Landers

DEDUCTING TRAVEL EXPENSES

Larry, I am going to Las Vegas for a convention and I want to take my spouse. Can I deduct her expenses?

Lou

Lou, I presume that you own your own business. I have some really good information on this and other topics on our website in the General Tax Information section. In response to your question, click on the following link:
http://www.kopsaotte.com/salon/documents/DEDUCTINGSPOUSESTRAVEL.pdf

Larry Kopsa CPA

NEW LAW WILL REQUIRE SOME S CORPORATION OWNERS TO PAY SUBSTANTIALLY MORE IN SOCIAL SECURITY AND MEDICARE TAX

I know one thing that is certain. Taxpayers hate paying self-employment tax. Hate it, hate it, hate it. Maybe it's because they know the tax goes towards financing Social Security - and they know better than to plan on retiring on Social Security. Now for some professional S corporations it appears that they will lose this wonderful tax advantage.

If you are in the following professions and if the principal assets is the reputation and skill (yet to be defined) of three or fewer workers, you are going to get hit starting in 2011.

• Accounting.
• Law.
• Health.
• Actuarial science.
• Engineering.
• Architecture.
• Lobbying.
• Consulting.
• Brokerage services.
• Investment management.
• Sports.
• Performing arts.

Currently, the tax is 15.3% of the first $106,800 in profits and 2.9% above that.

The change will end a popular tax saver for personal service S firms. Our strategy was to take a modest salary and receiving the rest of the profit as a dividend. The S corporation profits flow through to the owners’ individual income tax returns as dividends. Those dividends are exempt from self-employment tax, but they are hit with income tax.

We saw this coming. A few years ago, Treasury inspectors found massive tax avoidance in this area. More than 35,000 one-owner S companies with profits of $100,000 or more paid no payroll taxes on the profits because the owners didn’t take a salary. The same was true for owners of about 40,000 S firms with profits in the $50,000-$100,000 range. Because of this the tax writers decided to take action to end any possibility of gaming the system.

No exception will be allowed for amounts left in the firm for working capital, at least for small professional service S firms. Dividends passed through to owners of larger S service firms or of S corporations that aren’t in professional service fields will continue to be exempt from self-employment tax but the writing's on the wall. The iceberg is visible ahead. And we can't just sit around waiting for it to hit like the Titanic.

We'll obviously keep a sharp eye on this.

Larry Kopsa CPA

CALLING THE IRS

I don’t know if you’ve ever had the chance to call the IRS. I hope it never happens that you do. In our line of business we get this opportunity quite often.

I wanted to share with you the frustration of dealing with the IRS.

Recently I called regarding a client matter. After going through the tree of questions, what language I wanted to hear, the notice and ID number etc., I was finally told to wait, which I did for twenty minutes (which is normal). I then heard the beep that told me I might be next; I heard some crackling on the other end and then a dial tone. I spent twenty-five minutes sitting there waiting to speak to an IRS agent just to get cut off. I redialed the number and the same thing happened the second time.

These are the people who will be in charge of our health care.

RANDOM THOUGHT OF THE WEEK

"Map Quest really needs to start their directions on #5. I'm pretty sure I know how to get out of my neighborhood."