From diapers to private schools, children are expensive, as a recent thread on White Coat Investor illustrates. The dependency exemption is no help, as it phases out to zero for doctors and other high income professionals. But if you own a business, you can write off the cost of raising your child while teaching her about money, instilling the value of a work ethic, and giving her big start on retirement savings.
To justify hiring your child, the IRS requires the cost to be “ordinary and necessary”. This means you cannot grossly overpay him and his duties have to benefit or be necessary for your operations. If you own a business, there are probably many tasks that your child is qualified to handle.
Cleaning your office is obvious, as is running errands. Helping you with marketing is another opportunity – most kids know more than you about Twitter, Facebook, and Instagram. You can even “hire” toddlers to model for your blog or website. As your child grows, she can learn to keep books, answer the phone, and handle a variety of tasks specific to your particular business.
You should have a written employment contract specifying duties and pay for those duties. You might add a year-end bonus if certain requirements are met. And be sure to document the duties performed. (By the way, chores around the home do not count.)
Believe it or not, the IRS even gives you an extra “save” on payroll taxes: by hiring your children in your unincorporated business (LLC or sole proprietorship), you will owe no FICA taxes until she is 18. As long as she does not earn over her standard deduction amount ($6,300 in 2016), she will owe no federal income taxes (state laws will vary). If you’re in the 39.6% tax bracket, you will recoup over half of the amount you pay her in taxes saved, not counting state income taxes.
So how do you write off your child? Help him make up a budget – clothes, cell phone, gifts, t. He then uses his own money to pay for whatever is included in his particular budget. My dad allowed me to work as much as I wanted in his printing business but I was then expected to pay for my own clothes and extracurricular activities while saving for my first car. It was an extremely valuable lesson that I passed along to my own sons.
You can set up a Roth IRA for your child at any age and contribute the lesser of $5,500 or earned income to it. You may just want to gift her the money to contribute (add estate planning to our list of benefits!) or offer to match anything she puts in. Just imagine the years of tax-free growth ahead!
The earned income does not have to come solely from your business, either. Your child can have his own business – mowing yards, walking dogs, cleaning houses. All earned income counts toward his Roth contribution calculation.
So let’s see: you have deducted what you have paid your child, she has spent at least part of the money on her personal expenses and has started a Roth IRA. You have also reduced the future growth of her Roth IRA from your estate. You have accomplished many goals with this one employee.
How much better prepared will your children be when they follow your footsteps to medical school and residency? They will make good employees, have knowledge of the stock market, and live on a budget. Don’t you think a child who has been to the business school of Mom and Dad will finish training with less debt and more retirement savings than the average new attending?