The annual Roth IRA limit is $6,000 in 2019, up from $5,500 in 2018 (if you’re 50 or older, you get to add $1,000 to those amounts).
The maximum Roth contribution amount applies to all of your traditional and Roth IRAs, combined.
Roth IRAs also have income limits — at higher incomes, the amount you can contribute to a Roth begins to phase out, until the ability to contribute is eliminated completely.
The fine print on Roth IRA contribution limits is that you can’t contribute more than your taxable compensation for the year. That means that if your earned income is $3,000, your cap on Roth IRA contributions is also $3,000 for that year. If you don’t have any earned income during the year, you can’t contribute.The one exception is the spousal IRA, which allows a nonworking spouse to contribute to an IRA based on the taxable compensation of the working spouse.
So you may want to hire your child(ren) to work in your business. And you want to do it for many good reasons: to teach them about entrepreneurship, develop a strong work ethic AND for the tax-free income — up to $12,000 per child.
Fantastic. Adding your kids to your payroll can be a great strategy.
The Corporation “Problem,” and Its Simple Solution
There are different rules for different types of businesses. And that when the owners of a corporation hire their child, there are still payroll taxes like FICA to deal with.
We even pointed this out in your free guide. See for yourself:
"FICA tax may not have to be withheld on work performed by a child under the age of 18 while employed by a parent in an unincorporated business (sole-proprietorship, single member LLC or a partnership where the only partners are the child’s parents). However, there is no FICA or FUTA exemption for employing a child in an incorporated business (S or C Corp) or in a partnership that includes non-parent partners. In these cases, the children are subject to the same withholding rules that apply to all other employees."
So you DO NOT have to pay payroll taxes for employing your kids if your business is a sole-proprietorship, a single-member LLC taxed as a disregarded entity, or an LLC taxed as a partnership and owned solely by you and your spouse.
But if your business is a corporation, the IRS’s rules are clear. You must pay payroll taxes on income given to your children.
So are you stuck if your small business is set up as an S or C Corp? Or if you’re planning on switching to an S Corp like we normally recommend for maximum tax advantages?
Well, it turns out there is a workaround.
As one high-profile tax strategist says: in order to lower your tax, just change the facts.
Here’s how to do it:
The Payroll Tax Workaround for Your ChildrenIf your business is set up as an S or a C corporation, or as a partnership with other non-parent partners, the IRS says you have to withhold payroll taxes when employing your kids.
But there is a way to get around this restriction utilizing a little creativity and a “hybrid” approach.
Instead of paying your children directly from your S Corp, you pay them out of a family management company.
You can create this simple family management company as a Sole Proprietorship separate from your S Corp, and owned by yourself or your spouse.
Its only purpose is to support the operations of your Corporation, which can include the scheduling and monitoring of jobs done by your child(ren) — and all the bookkeeping and documentation necessary to keep the jobs within IRS standards.
The family management company charges the Corporation a management fee for these services and can then pay your child — which removes them from your corporate payroll.
And since the family management company is a Sole Proprietorship owned by a parent, you or your spouse, it falls under the IRS exemption where payroll taxes don’t have to be withheld.
By following this workaround, you’ve found a way to truly pay your kids $12,000 per year tax-free using nothing but the IRS’s own rules.
Keeping It All Legitimate
Just like you don’t want to create some sham job for your kids to shield income from taxes — you don’t want to just “say” you have a family management group to pay the kids.
If the Internal Revenue Service audits you, you’ll have to show that the family management company (run by one of the parents) actually did schedule and document the children’s work.
And as always, the better records and documentation you keep of their time worked, the easier any audit will be.
Is the Work Worth It?Does the strategy of setting up a separate family management company to pay your children add a little extra complexity to the strategy? Sure. But no more complexity than having to withhold and submit payroll tax.
And if you have multiple children, the cost savings can be significant.
Is this an aggressive tax strategy? A so-called “conservative” CPA might say yes. However, it’s also perfectly legal if you do it right. You’re just changing the facts to match what the IRS code allows.
Remember, the tax courts agree individuals have the right to strategically use the tax code to their advantage and lower their tax burden.
But the IRS isn’t going to help you find the strategies, either. That’s up to you.
The key is to have a qualified tax strategist set up the plan and show you the rules to follow. Then, as long as you document everything carefully, there is nothing to fear when using legitimate tax strategies.
The Bottom Line:When you put your child on the payroll, you divert income from your higher tax bracket into their lower tax bracket. And if you do it right, it further reduces your taxes with a business deduction for the wages paid.
Your children can then pay for their own expenses where appropriate, save for their own college and even pay their own way on family vacations.
We’ve seen this strategy save clients thousands of dollars in taxes and build stronger families. Children develop a work ethic and learn the value of money — and it can draw a family together in ways never fathomed by small business owners.
So talk to your CPA or Tax Attorney about getting your kids to work in your business today.
The NY Accounting, Tax and Advisory Expert Blog