If you own a Schedule C business (sole proprietorship), here's a way to get the kids a summer job and also save on taxes. A Schedule C business owner can save family income and payroll taxes by putting a junior family member on the payroll. Let's look closer.

What we are looking at here is income shifting, or bracket shifting. Shifting some of the earnings of the business to the child as wages for services rendered can reduce income and employment taxes. Obviously, the work done must be reasonable in order for the business to get a deduction, but it doesn't have to be technical or professional in nature. An example:

One of my clients, Janet, is a Certified Financial Planner (CFP), and she operates as a sole proprietor and files a Schedule C. This summer, Janet is planning on upgrading, updating, and generally cleaning up her client files. She also needs some "fill in" help during the summer in order to cover vacations, etc. Janet plans to hire her 16-year-old son, Tom, to do this work. Tom will work full-time over the summer and will earn $4,000.

Well, Janet is very successful and is in the 36% tax bracket. Tom has no other income, and the wages Tom will earn (reported on W-2 form that he will receive from Janet) will be offset by his standard deduction. Therefore, Tom's earnings are completely sheltered, and he will pay no tax on that income. Janet, on the other hand, will reduce her income by $4,000, thereby saving her $1,440 in income taxes.

And it gets better. Janet will save on social security and Medicare taxes (FICA) -- at least the Medicare portion -- and Tom's wages are not subject to FICA taxes at all. Internal Revenue Code Section 3121 clearly states that employment for FICA tax purposes doesn't include the services performed by a child under the age of 18 in the employ of his mother or father.

So in this example, Janet's SE (Self-Employment) income would be reduced by $4,000, saving at least $116 (the 2.9% Medicare portion of the FICA tax). And, if Janet is not over the FICA limit ($62,700 net earnings in 1996), she will save an additional $496 in SE taxes in 1996. The actual SE tax savings would be slightly less than shown because Janet gets an income tax deduction for one-half of the extra SE taxes if they would have been paid. But I think you can see how the numbers (and savings) work.

And remember, Tom has no FICA tax to pay, either at the employee or employer level. Nice deal, eh? Janet could save an additional $720 in income taxes (and also reduce her SE taxes) if she could keep Tom on the payroll for a longer period of time and pay him an additional $2,000. Tom could shelter this additional income by opening up an Individual Retirement Account(IRA) and making a tax deductible contribution. Also, there is a similar, but more liberal exemption applicable to FUTA (Federal Unemployment Tax) payroll taxes that can be avoided by the employer.

A few issues that you might want to consider:

---The "Kiddie Tax" might come into play here if your child is under age 14 and has other investment income. But remember that the kiddie tax applies only to unearned income. Earned income is not subject to the kiddie tax, and can still be sheltered by the child's standard deduction. So check the effect of the kiddie tax, if any, before and after employment income. In general, I think you'll find that a tax saving opportunity still exists, regardless of the kiddie tax issues.

---Even if all of Junior's earnings cannot be sheltered by the standard deduction and an IRA deduction, remember that Junior will still be in the 15% tax bracket, while the parent will be in a higher bracket. Even if it works out that Junior has a tax liability, that liability will probably be less (and in some cases much less) than the parent's tax liability.

---Also remember that the business can provide retirement benefits to Junior. For example, if the business has a Simplified Employee Pension (SEP), a contribution could be made for Junior up to 15% of Junior's earnings. Since Junior's adjusted gross income will probably not be in excess of the statutory amount, Junior would still be allowed to take his IRA deduction on his tax return. This amounts to a TRIPLE DIP!

But be careful about the SEP or any other retirement plans. There are many non-discrimination rules that must be followed. If you have other employees, you will most likely be obligated to cover the other employees just as you cover Junior. So unless you are prepared to do so, don't just jump right in. However, the SEP plan works very well for those Schedule C business owners who are truly sole proprietors and have no other employees to deal with, nor anticipate them in the near future.

So there you have it, you Schedule C business owners. Check this out. It might just save you some income tax and employment tax dollars.

- Article 19

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