Deduct Your Child’s Allowance: Tax Savings by Owning a Small Business

Are You Getting All Your Deductions?
Are You Getting All Your Deductions?

If you’re self-employed, many deductions are available to you that the average person without a business can’t take advantage of. If you don’t have a small business, you might consider the many financial benefits of starting one. Simply making an honest effort to earn income from what usually is just your hobby can open up many tax advantages, even if you keep a regular full-time job.

One often-overlooked tax benefit for business owners is putting their kids to work in their business.

If you are self-employed, you can take advantage of this by paying your kids $4,000 each for performing services in your business. The business gets a tax deduction for the compensation, saving taxes on the parent’s tax return. Also, there are no Social Security or Medicare Taxes due on the wages you pay to your child.

The next step is to open a Roth IRA for the child and contribute the $4000 to the IRA. The child may not withdraw this money until age 59 ½. The earnings and the amounts contributed grow tax-free and are generally never subject to tax when withdrawn. On the child’s tax return, the child gets no tax deduction for the IRA, but the child may not pay tax on the $4000if they are at a low enough income.

If you do this for ten years, from age 8 to 18, and the IRA earns an 8% return each year, your child should have around $1.5 million at age 60, which should grow to over $2 million by age 64.

If you plan to do this, consult a professional tax advisor first and be sure your children are performing services for your business. Also, check that the work is not violating any child labor laws.

If you are looking for more tax suggestions for your small business, look at Nolo’s Tax Savvy for Small Business by Frederick Daily and Deduct it! by Stephen Fishman. You get a list of the rules, suggestions, and approaches to deductions and structure to maximize your tax savings.

The information contained herein is not intended as tax advice. To comply with requirements imposed by the IRS, any information contained in this communication cannot be used to avoid penalties under the Internal Revenue Code.

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