You could be saving more on taxes and expenses.
The Tax Cuts and Jobs Act raised the standard deduction for single taxpayers. The deduction now amounts to $12,000 and will increase every year to allow for inflation, until January 1, 2026. Why is this good news for business owners with children under 18 years of age? It allows a child to earn up to $12,000 in W-2 wages and not pay any federal income tax.
Medical practice owners can employ their young children to work for their business, and simultaneously have access to a tax saving opportunity.
Who benefits the most? Self-employed Schedule C individuals, spousal partnerships and single member LLCs that did not elect corporate tax treatment. Why? Because these businesses are exempt from federal payroll tax (FICA) when employing children under 18 years of age, in addition to not having to pay unemployment taxes for children under 21.
S and C corps, as well as non-spousal partnerships do not qualify for a parental benefit. These entities must pay payroll taxes on all employees, including their children. The tax savings would be reduced by the costs of both employer and employee (child) FICA, as well as federal and state unemployment taxes. This, however, does not mean that this strategy is worthless in case of S or C corps. The savings are reduced, but not eliminated.
As an example, let’s say you are self-employed physician with two children, 11 and 13 years of age. You pay each child $12K within a single year. The children do not incur federal income taxes and you claim a business deduction of $24K, reducing both your income tax and self-employment tax. If your taxable income is $300,000 and you’re filing as a single individual, you are in 35% federal income tax bracket; and you’re also subject to self-employment tax and Additional Medicare Tax. In this example, your tax savings will be $9,129 ($8,287 income tax saving, and $842 self-employment tax savings). Over a 5-year period, the savings would be just over $45K.
Of course, employing children does come with several caveats, but if done correctly (and it is paramount that this be done correctly!) the savings can be substantial, and the benefits would not be limited to reducing tax liability.