Many families choose to give their kids an allowance every week or month in exchange for doing chores or other work around the house. While not all business minds are fans of giving kids an allowance, it can act as a great way to teach your kids the value of money from a young age. If you want to give your kids an allowance anyway, you might want to pay them from your business instead of handing over cash. There are several benefits, including potential tax savings for you, when you pay your kids’ allowance from your business.
Lower taxes for your business
The number one reason to pay your kids from your business instead of your wallet is taxes. If you pay your kids from your business, that lowers your business net income for the year, and effectively lowers your taxes. For example, let’s say you pay your two kids $20 per week each. That is $2,080 per year in payments to your kids. Let’s say you are in the 25 percent tax bracket and your business is taxed as a pass-through entity. That would save you about $520 on your taxes come April.
Keep in mind, there are a few requirements for this to work. First, the kids have to be under 18 years old or you have to pay Social Security and Medicare taxes for them, which might be enough to cost you more than you save in taxes. Also keep in mind that the child technically has to be doing some work for the business, according to IRS rules. But if you own a business, it is easy to put your kids to work. From stuffing envelopes to data entry, you can ensure your kids really earn their pay. As long as the compensation rate is “reasonable” and you comply with child labor laws, this can be a great opportunity to save.
Give your kids IRA savings opportunities
Americans can contribute up to $5,500 per year in a traditional or Roth IRA ($1,000 more for those ages 55+), up to their earnings for the year. If you pay your kids a paycheck that requires W-2 reporting to the IRS, as is the case with any employee, that income counts toward the limit of IRA contributions. Even if your kids spend their paychecks on video games and other shopping, you can contribute to an IRA in their name up to that earnings limit.
A Roth IRA is one of the best gifts you could ever give your child. It is money that will grow in an investment account for decades until they reach retirement and can withdraw from the account tax free. You may not be around when your kids turn 65. However, you can count on your kids being very appreciative of the gift you left them as a child. If $1,000 grows over 50 years at an average 10% per year, they will end up with nearly $150,000! Plug your numbers into this investment calculator to find out how much you may be able to help your kids save for the future.
Beware the costs
Before you dive in and start paying your kids from the business, keep in mind some potential drawbacks. Expanding your business to include additional employees may change your insurance requirements and other tax filing requirements. If you don’t already pay yourself and/or other employees with a payroll service, you would have to add one for this to work. If that would mean getting started with a new payroll vendor, the costs may be enough to offset any tax gains.
Insurance concerns come from workers compensation, where going from a solo employee business to one with multiple employees could trigger certain requirements. But if you already have a staff and a payroll service, that shouldn’t be too big of a worry, as you are already paying those costs and they should not go up much, if at all.
Ease your child into a valuable experience
There is something more valuable than money that your kids get out of working in your business for an allowance: experience. Give your kids an opportunity to learn from you about entrepreneurship, business, managing money, taxes, savings, and more. Maybe you kids will be so inspired they join your business full-time after college. Maybe they’ll go on to found their own entrepreneurial endeavor.
Whatever they decide, you can save on taxes in the meantime, as long as you do everything by the book.