There are plenty of advantages that real estate investing provides over other forms (including stocks). One of them is the sheer simplicity of making your children millionaires, and at a discount to you. The key to this simple trick is employment. Employ your children and pay them wages. Take those wages (which they probably won't have to pay taxes on) and put them in a Roth IRA for them.
First I need to make a quick legal disclosure. I'm not actually a lawyer, though I'm sometimes mistaken as one. The basis of the child labor discussion in this article is the federal Fair Labor Standards Act (FLSA), but every state has their own additional labor laws. While I feel confident that my recommended course of action shouldn't violate any laws, you should further research the child labor laws in your own state.
However, with that boilerplate out of the way I should tell you that child labor laws are generally designed to prevent people from exploiting children and protecting them from dangerous work environments. Since our purpose isn't to exploit our child's labor, but rather to expose them to the world of business and investing (as well as give them a financial head start), we're probably safe from that first condition. And the most dangerous thing our child may experience in our line of work is a rabid mortgage broker, so we're probably covered with the second as well.
What if your child's iPod was tax deductible?
There are obvious life lessons that can be taught through paying your children a wage. Younger children can learn the money results from doing work, not begging their parents. Other lessons, such as saving and budgeting, can be very easily incorporated. However I'm not a psychiatrist, nor am I Dr. Phil, so I'm going to refrain as much as possible from telling you how to parent. Instead I want to focus on how paying your children affects you.
When you pay your child (or any other employee of your business) those wages are deducted from your income in the same way as any other expense. If your company made $100,000 last year and you spent $10,000 on advertising and $10,000 in paying your children, the IRS will only tax $80,000. OF course the IRS doesn't just forget about the $10,000 you paid your children, that money is now their (taxable) income.
However, generally, children are taxed the same way as everyone else, and they are entitled to the same deductions as everyone else. This year the standard deduction for a single tax-payer is $5,000. So if your child earned $5,000 from you this year that money is entirely income tax-free. If you are in the 28% tax-bracket, you have just saved your family $1400 in taxes. No matter how that money is spent (on clothes, to fund a Roth IRA or on an iPod), you've avoided the taxes.
How do I deal with my child's income, and what about taxes?
The IRs tells us that a minor only has to file a return if they earn over $5,000. This actually get slightly more complicated to figure out if your children have unearned income as well (like stocks), but odds are that you won't even have to file paperwork with the IRS unless you need to get a tax refund.
But the refund is a moot point since, if your child is earning that little, you don't have to withhold any money for the government (though you will have to report the earning, which is discussed later).
So we don't have to give the government any money for the child's income taxes, but what about Social Security? If you run your business as a sole proprietorship, general partnership, or an LLC that is taxed like one of those two entities, niether you nor your child will be responsible for paying any social security taxes. If instead you chose to form a corporation, or an LLC that is taxed like a corporation, you unfortunately will be responsible for paying Social Security.
Yet another reason why I don't recommend incorporating yourself.
So how can I put my child to work and what should I pay them?
Generally children under the age of 14 are not allowed to work. However the federal law exempts the age restriction on parents who are employing their children (section 29 CFR 570.2 - Minimum age standards). So the federal law places no restriction on the age at which your child can begin to work.
It's worth noting, however that the age exemption only applies to parent's or "those playing the role of a parent". It appears that the court interprets "playing the role of a parent" as raising and providing for the child, so unless you are directly raising your nephew/grandchild/cousin, you are not allowed to hire them at younger than 14. In addition you cannot hire your grown child, who then hires their minor child. The parents must own the business in order to exercise this exemption. Of course, once the child reaches the age of 14, they can be hired by anyone regardless of relation.
Pay is something that is left to the employer, all that's mentioned in the laws is that they are to be paid a fair wage. Paying too high will probably be more of a problem for us than paying too low.
It's highly unlikely that the FBI will be knocking down our doors for violation of child labors laws, so it seems that our chief concern lies with the IRS. Part of your reasoning for hiring your child is the tax benefits, and the IRS's job is to get you to pay every last cent that they legally can. Hiring your children, though completely legal, is likely to run up a red flag at the IRS and they'll probably keep a somewhat closer eye on you. To protect yourself in the event of an audit, you'll need to follow a few steps.
- Request an Employer Identification Number (EIN). This is required before you can hire anyone, and it's a free simple process created by the IRS.
- Assign jobs that are acceptable for your child's age. An 6 year old could help you fold letters or lick stamps. A 10 year old could help you rake leaves on a rental property. A 14 year old could help you paint.
- Only pay them for jobs that are directly related to your business. Mowing the lawn of a rental property applies. Mowing your lawn doesn't (you can still pay them for mowing your lawn, you just can't deduct it from your business).
- Keep a detailed record of all of your children's hours and efforts. Use a notebook or a spreadsheet, but carefully record dates, hours worked and work accomplished. Don't record that your 6 year helped you fix the plumbing, instead record that he/she held the light for you to see what you were fixing.
- Pay a fair wage. Don't pay your children $50 an hour to lick stamps.
- Issue a W-2 at the end of the year for your children. Each child should get their own.
- File a 944 form with the IRS every year. The 944 Form is your way, as an employer, of notifying the IRS of the wages you paid out. Without this form, they'll view your deductions as very suspect (and probably illegal). By the way, the 944 form is a new, annual version of the old 941 form that had to be submitted quarterly. You can only use 944 if your employees' tax liability (the amount they are expected to pay in taxes) is less than $2500.
And if you get your children to work for you from age 10 until age 18, putting $3,500 away each year into a Roth IRA, earning 10% a year, they could go to college with nearly $50,000 tucked away, TAX FREE. If they never save another dime (just the original $28,000 you put away for them) they'll be millionaires before they are 50.