Many Business owners today are looking for ways to save on taxes but didn’t know that they can pay their kids at a lower tax rate for work the kids do around the office. This strategy is one that has been around for a long time, but doesn’t get talked about as often as it should be. It’s been around for a long time, long enough that my wife used to help clean her dad’s office back in the 1990’s.
Let me take some time to explain the math, as you may be asking “why would I take my money and give it to my kids?” Currently the tax brackets are pretty generous, but its looking like after 2021 they won’t be as generous. Nonetheless lets look at the 2021 Tax Brackets,
Let’s assume that in 2021 a business owner was on track to make $300,000. This would put them in the 24% tax bracket. If they decided to pay their child $6,900, that child would be taxed the self employment tax which is 15.3%. So they would get a savings of 8.7%, and allow their child to put $6,000 into a Roth IRA. With this strategy a business owner would not only pay less taxes, they allow their child to start saving in the best possible investment vehicle (in my opinion) a Roth IRA.
The saving of this strategy get better as the business owner earns more income. It is a 16.7% savings at the 32% bracket, 19.7% savings at the 35% bracket, and a 21.7% savings at the 37% bracket. This strategy can also be repeated for each subsequent child a business owner has. Children are able to earn up to $12,200 before they have to file their own tax return, so technically you could pay them up to that amount without creating too much more hassle.
The most difficult part of this strategy is how to pay your kids $6,900 per year, because it needs to be earned income, otherwise its just a gift, and gifts can’t necessarily be put in a Roth (side note you can gift kids money to put in their Roth but they also have to have the same amount of earned income to be able to put money in a Roth). Below are some ideas of ways that you can pay your kids in the business so they can put money in a Roth IRA.
The IRS is always watching, so we encourage you to find true ways to have your children earn income. But with a little bit of thought and planning we are confident you can find a way to pay your kids through your business to help you and them. As I mentioned above, one of the greatest parts of this strategy is allowing your children to invest in a Roth IRA. HERE is a great article that discusses Roth IRAs and Traditional IRAs for kids. We love the strategy because we are taking taxable income for the parent and turning it into TAX FREE future income for the child. For some kids this money could grow tax free for 60 or more years. Using an 8% interest rate that $6,000 could turn into $607,542 in 60 years. That means this one strategy could turn $6,900 of income into $600,642 of TAX FREE income for your child. This strategy doesn’t work for all business owners, but if you are in the 24% tax bracket or above we think you should highly consider this strategy.