19.7 – Shifting Income to Kids
Hiring Kids + Avoiding Gift Tax
Sole-Proprietors and spousal partnerships can pay children up to $12,000 without
incurring any tax neither income nor payroll for legitimate services rendered to
the business based on a market rate of pay. S and C corporations and non-spousal
partnerships can also take advantage of this strategy; however, they are not exempt
from payroll taxes.
You will be glad to know IRS has accepted hiring kids as young as 7 years old.
Duties include: Videographer, social media management, editing, shredding, admin
work, etc.4
You can gift $15k per year to as many separate people as you want and not have to file a gift tax return.
If you exceed $15k to any one person in any one year, you must file a gift tax return (reduces your lifetime gift exclusion of $11.58MM).
Inheritance:
- Decedent’s estate pays tax on the value of estate less lifetime exclusion.
- Beneficiaries receive stepped up basis in assets
Reduce the taxable estate by gifting $15k per year per child/grandchild OR by making a $75k contribution to a 529 plan (5 years worth of gifts, cannot gift more to the child during next 5 years)
Best practice: Gift 15k a year to offspring without having to file a gift tax return
Children’s Unearned Income (kiddie tax)
The first $2,200 of unearned income for a dependent child is not taxed at all, however, any unearned income above this amount is taxable at trust tax rates.
You can make an election to tax additional income at a parent’s rates.
What is unearned income? (Exemption to FSLA Child Labor Laws if the business is parent-owned)
- Interest and dividends
- Capital gains
- Rents and royalties
- Annuity income and pensions
- Taxable scholarships and unemployment compensation
- Income (other than earned income) received as the beneficiary of a trust
Children’s Earned Income
Dependents can receive earned income up to $12,400 (standard deduction) tax-free. No issue with kiddie tax, since we’re talking about wages (earned income).
Federal Insurance Contributions Act (FICA) Tax
Avoid FICA taxes on wages to a child under 18 years of age. If your business is an S or C-Corp, you must pay FICA taxes.
Ways to Reduce Earned Income
- Write as tax deduction for the business
- Have your child contribute to a Roth IRA and grow earnings tax-free
- Or have your child contribute to a traditional IRA so you can now pay them $18,400 tax-free ($12,400 + $6,000 contribution)
What can a child at a given age reasonably do?
- A 7-year old can’t keep the books for you… but they can sweep the floors
- An older child can answer phones, clean, file paperwork, or perform other clerical work
- Teenagers can help you with repairs and maintenance (or do it themselves)
- Modeling is risky to qualify as work
The wage you pay your child must be “reasonable”
● What would you pay an unrelated third party for the same amount of work or hours?
● Ray, TC Memo 2018-160: taxpayer paid 5 children (“office assistants”) $260k. Denied. Have a signed employment contract!
Best practices: Kids use the income to start a Roth IRA or fund an IBC account
Irrevocable Trusts
Irrevocable trusts are a step beyond LLCs for asset protection. They can cost 10-50k to setup and therefore mostly for multimillionaires concerned with liability. For more information about irrevocable trusts check out the legal section. They can be very tricky based on how you pay taxes. If you are at this level we suggest joining the FOOM and getting legal counsel on taxes from your attorney.
IMPORTANT!
DO NOT GIFT A PROPERTY (IN MOST CASES) TO AN OFFSPRING BECAUSE YOU LOSE THE STEP UP BASIS!
It’s a nice thing to do but allow your kids to get the step-up basis.
