Summer jobs for young people have become increasingly hard to find. If your child is just sitting around this summer, think about hiring him or her to work in your real estate business. There are probably lots of things your child can help you with, such as answering phones, helping with your website, stuffing envelopes, or cleaning the office.
Believe it or not, your children’s employment can offer tax savings, too. If you hire your child as an employee to do legitimate work in your real estate business, you may deduct the child’s salary from your business income as a business expense.
Of course, you must take care to comply with all applicable child labor laws. The Fair Labor Standards Act generally "sets 14 as the minimum age for employment, and limits the number of hours worked by minors under the age of 16," according to the U.S. Department of Labor website.
Your child will have to pay tax on the salary only to the extent it exceeds the standard deduction amount for the year, which was $5,800 in 2011. Moreover, if your child is under 18, you won’t have to withhold or pay any FICA (Social Security or Medicare) tax on the salary (subject to a couple of exceptions).
These rules allow you to shift part of your business income from your own tax bracket to your child’s bracket, which should be much lower than yours (unless you earn little or no income). This can result in substantial tax savings.
Rules to follow when employing your children
However, the Internal Revenue Service is well aware of the tax benefits of hiring a child, so it’s on the lookout for taxpayers who claim the benefit without really having their child work in their businesses.
If the IRS concludes that the child isn’t really an employee, you’ll lose your tax deductions for the child’s salary and benefits. And the child will have to pay tax on benefits received. To avoid this, you should follow these simple rules.
Rule 1: Your child must be a real employee
First of all, your child must be a bona fide employee. The work performed by your child must be ordinary and necessary for your business, and the pay must be for services actually performed.
Services performed by your child don’t have to be indispensable — only common, accepted, helpful and appropriate for your business. Any real work for your business can qualify. You get no business deductions when you pay your child for personal services, such as babysitting or mowing your lawn at home.
On the other hand, money you pay for yard work performed on business property could be deductible as a business expense.
You should keep track of the work and hours your child performs by having the child fill out time sheets or time cards.
You can find these in stationery stores or make a time sheet yourself. It should list the date, the services performed, and the time spent performing the services.
Although not legally required, it’s also a good idea to have your child sign a written employment agreement specifying his or her job duties and hours. These duties should be related only to your real estate business.
Rule 2: Compensation must be reasonable
When you hire a child, it is advantageous (taxwise) to pay the child as much as possible. That way, you can shift as much of your income as possible to the child, who is probably in a much lower-income tax bracket.
However, you can’t just pay any amount you choose: Your child’s total compensation must be reasonable.
Total compensation means the sum of the salary plus all the fringe benefits you provide, including health insurance and medical expense reimbursements, if any. This is determined by comparing the amount paid with the value of the services performed.
You should have no problem as long as you pay no more than what you’d pay a stranger for the same work — don’t try paying your child $100 per hour for office cleaning just to get a big tax deduction.
Find out what workers performing similar services in your area are being paid. For example, if you plan to hire your teenager to help answer the phone, call an employment agency or temp agency in your area to see what these workers are being paid.
To prove how much you paid (and that you actually paid it), you should pay your child by check, not cash. Do this once or twice a month, as you would for any other employee.
The funds should be deposited in a bank account in your child’s or spouse’s name. Your child’s bank account may be a Roth IRA, Section 529 college savings plan, or custodial account that you control until your child turns 21.
Rule 3: Comply with legal requirements for employers
Finally, you must comply with most of the same legal requirements when you hire a child as you do when you hire a stranger. This means you must fill out IRS Form W-4 and complete U.S. Citizenship and Immigration Services (USCIS) Form I-9: Employment Eligibility Verification.
You must also record your employee’s Social Security number. If your child doesn’t have a number, you must apply for one. In addition, you, the employer, must have an Employer Identification Number (EIN).
If you don’t have one, you may obtain it by filing IRS Form SS-4. You must also complete and file IRS Form W-2 showing how much you paid your child.
IRS Circular E: Employer’s Tax Guide, and Publication 929: Tax Rules for Children and Dependents, provide detailed information on these requirements. You can download them from the IRS website at www.irs.gov.
Stephen Fishman is a tax expert, attorney and author who has published 18 books, including "Working for Yourself: Law & Taxes for Contractors, Freelancers and Consultants," "Deduct It," "Working as an Independent Contractor," and "Working with Independent Contractors." He welcomes your questions for this weekly column.