July 9, 2020

As you know and have likely experienced, many small businesses have been hurt by the COVID-19 crisis.  Making smart moves right now can help ensure you emerge from the COVID-19 crisis and its aftermath a winner.

In this article, we explain why one smart move could be hiring one or more family members to work in your business. That could help your business and your family in meeting COVID-19-caused cash-flow challenges while also delivering favorable tax results to both the newly employed family member(s) and your business (think double benefit).

We will start with the favorable tax results for newly employed family member(s). Then we will cover the favorable tax results for your business.

HIRE YOUR UNDER-18 CHILD

Let’s say you operate your business as a sole proprietorship, a single-member LLC that’s treated as a sole proprietorship for tax purposes, a husband-wife partnership, or an LLC that’s treated as a husband-wife partnership for tax purposes.

That means you can hire your under-age-18 child, and the child’s wages will be completely exempt from Social Security and Medicare taxes (FICA tax) and Federal Unemployment Tax Act (FUTA) taxes. To be clear, the FICA tax exemption applies to the employee’s share of FICA tax that’s withheld from the employee’s paychecks and to the employer’s share of FICA tax that your business must pay over to the Feds.

  • For 2020, your child’s standard deduction will shelter from federal income tax the first $12,400 of wages received if the child has no taxable income from other sources. (This assumes your child files as a single taxpayer for 2020.)   No federal income taxes for this child. Not a bad deal!

You can hire your child part-time, full-time, or whatever works for you and the child. Right now, children in this age category are probably not attending school, and the school district’s lengthy summer vacation may have already begun.  In the fall, will your child be attending school in person or online? You probably don’t know anything for sure at this point. But in the COVID-19 era, your under-age-18 child’s availability to work in your business may be at an all-time high.

The wages received by your child can be used to help keep the family afloat financially. If your family is not so financially stressed, your child can use some or all of the wages to fund a college savings account or make a Roth IRA contribution.

WHAT IF MY CHILD IS AGE 18 OR OLDER?


If your newly employed child is 18 or older, the child’s wages are subject to Social Security and Medicare taxes (FICA tax), just like any other employee.  On the plus side, the wages are exempt from FUTA tax if:

  • the child is under age 21 and
  • your business is operated as a sole proprietorship, a single-member LLC that’s treated as a sole proprietorship for tax purposes, a husband-wife partnership, or an LLC that’s treated as a husband-wife partnership for tax purposes.

Here’s the best part:  For 2020, your child will owe:

  • no federal income tax on the first $12,400 of wages received from your business if the child files as a single taxpayer and has no taxable income from other sources. This is true regardless of the child’s age, thanks to the child’s standard deduction.
  • no federal income tax on the first $24,800 of wages received from your business if the child is a married joint-filer and has
  • no taxable income from other sources. This is true regardless of the child’s age, thanks to the standard deduction.
  • no federal income tax on the first $18,650 of wages received from your business if the child files as a head of household and has no taxable income from other sources. This is true regardless of the child’s age, thanks to the child’s standard deduction.

WHAT IF MY BUSINESS IS INCORPORATED?
If you operate your business as an S or a C corporation, your child’s wages received from the business are subject to Social Security and Medicare taxes and FUTA tax, just like any other employee, regardless of the child’s age.

WHAT IF I HIRE A FAMILY MEMBER OVER AGE 21?
Do it! The wages received from your business are subject to Social Security and Medicare taxes (FICA tax) and FUTA tax, just like any other employee. This is the case whether you operate your business as an unincorporated sole proprietorship, a partnership, or an LLC or as an S or a C corporation.

For 2020, the family member will owe:

  • no federal income tax on the first $12,400 of wages received from your business if he or she files as a single taxpayer and has no taxable income from other sources.
  • no federal income tax on the first $24,800 of wages received from your business if he or she is a married joint-filer and has
  • no taxable income from other sources.
  • no federal income tax on the first $18,650 of wages received from your business if he or she files as a head of household and has no taxable income from other sources.

TAX ADVANTAGES FOR YOUR BUSINESS


When you hire a child or other family member, your business deducts the wages paid. Of course, the wages must be reasonable for the work performed.

  • If you operate the business as a sole proprietorship, a single-member LLC that’s treated as a sole proprietorship for tax purposes, a husband-wife partnership, an LLC that’s treated as a husband-wife partnership for tax purposes, or an S corporation, the wage expense deduction reduces (a) your individual federal taxable income, (b) your individual net self-employment income, and (c) your individual state taxable income (if applicable).
  • If you operate the business as a sole proprietorship, a single-member LLC that’s treated as a sole proprietorship for tax purposes, a husband-wife partnership, or an LLC that’s treated as a husband-wife partnership for tax purposes, wages paid to your under-age-18 child are exempt from the employer’s share of FICA tax, as explained earlier.
  • If your employee-child is over age 17 but under age 21, the FICA tax exemption disappears, but the wages are exempt from FUTA tax.
  • If you operate the business as a C corporation, the corporation deducts the wages paid to a child or other family member. The deductions reduce the corporation’s federal taxable income and probably the corporation’s state taxable income (if applicable).
  • If your business will be unprofitable this year due to the COVID-19 fallout, deductions for wages paid to a child or other family member can create or increase a net operating loss (NOL) for 2020. If so, you can carry back the 2020 NOL for up to five tax years—back to 2015. The NOL carryback can trigger a refund of income taxes paid for the carryback year. That can really help. An NOL carried back to a pre-2018 tax year can be especially helpful, because tax rates were generally higher in those days. (The federal income tax rate cuts included in the Tax Cuts and Jobs Act (TCJA) first kicked in for tax years beginning in 2018.)

FINAL THOUGHTS
If you have a child or other family member who currently has no income from other sources, making that child or other family member an employee of your business can make a lot of sense. Some things to consider:

  • Pay reasonable wages for the work performed to lock in your tax-saving federal income tax wage expense deductions. You can pay higher wages to children or family members who are teenagers or older, because they can be assigned more-meaningful tasks.
  • Keep payroll records just like you would for any other employee to document hours worked and duties performed (e.g. time sheets and job descriptions).
  • Issue W-2s just like you would for any other employee.

With pay equal to or less than the standard deduction, the child or other family member pays no taxes on the wages.  And, your business deducts the wages paid.

Think of it this way: with no tax on the wages and a tax deduction for the wages, you created cash for the family.

If you have any questions about what we discussed above, please give us a call. As always, we are in your corner!

Team Legacy CPA
(541) 326-0993