The hire-your-child strategy works best for the Schedule C proprietorship because when the proprietor hires his or her under-age-18 child, the tax code exempts both the child and the proprietorship from payroll taxes.
That’s great for proprietorship owners who have children under age 18. But if you hire your child and operate as a corporation or your child is age 18 or older, both you and the child suffer payroll taxes.
This article gives you a strategy to avoid payroll taxes on children over age 18 and on children doing work for your corporation.
Let’s say that you could pay your child $23,225 with this strategy:
- You deduct the $23,225 in your high tax bracket.
- Your child pays $1,028 in taxes.
That’s a good return on investment.
Net Earnings from Self-Employment
The tax code says, “The term ‘net earnings from self-employment’ means the gross income derived by an individual from any trade or business carried on by such individual . . .”
The Supreme Court ruled that to be in a trade or business, you need to be involved with continuity and regularity and that a sporadic activity does not qualify.
Putting the Strategy in Play
If you contract with your child to perform a one-time task such as build your business a website, create several business videos, install office windows, or paint the office or building, your child is not in a trade or business.
Also, that one-time task is not likely to make your child an employee. Make sure you don’t cross the line and make your child an employee.
And since this is not a trade or business and only a for-profit endeavor, you don’t want your child to incur any expenses, because the Tax Cuts and Jobs Act disallows for tax years 2018-2025 miscellaneous itemized deductions subject to the 2 percent of adjusted gross income floor.
If you need windows installed, your best bet is to have your business buy the windows and installation material.
If you goof this up, it’s likely that your child can deduct the windows and installation materials as a cost of sales. But that creates paperwork for the child and possible disagreeable discussions with the IRS.
In Batok, the court ruled that John Batok’s installation of windows did not rise to the level of a trade or business. Mr. Batok’s activity, although engaged in for profit, was neither continuous nor regular. He had never installed windows prior to this effort nor at any time thereafter.
The court ruled that Mr. Batok’s activity was a “one-time job” not subject to self-employment taxes.
Member of Congress
Rev. Rul. 77-356 states the following:
Although the Member of Congress is a public official in the performance of congressional duties, the income from the speaking engagements is not derived from performing those duties. The income from giving speeches is derived from the separate trade or business of speech making.
As a separate activity from congressional duties, speech making may or may not rise to the level of a business.
In Rev. Rul. 55-431, the IRS concludes that an individual who accepts an occasional invitation to make a speech for which he or she receives an honorarium is not engaged in a trade or business for self-employment tax purposes.
On the other hand, the IRS ruled that the member of Congress who gave 10 speeches where he accepted honorariums was in the trade or business of speech making, and therefore was liable for self-employment taxes on that speech-making income.
You likely noticed the gray area between “occasional” and “10” paid speeches where speech making may or may not be a trade or business subject to the self-employment tax. This simply points out that this is a facts-and- circumstances area where the IRS looks at the degree of recurrence, continuity, and availability for speech making, along with the amounts received during the year.
With your child’s effort, look to a one-time activity as a great bet for avoiding the self-employment tax.
The one-time project can avoid having your child on the payroll, and it can give you the best of all worlds.
For example, say you are in the 40 percent federal bracket and you pay your 20-year-old college student $23,225. You deduct the $23,225 and save $9,290 on your taxes.
Your child pays $1,028 in taxes.
Think of it this way: the family unit (you and your child) are in the green by $8,262 ($9,290 - $1,028).
Green Krist, CPA specializes in assisting taxpayers with IRS and North Carolina Department of Revenue issues in the greater Raleigh, North Carolina area.