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Tap Into These Changes in Kiddie Tax Laws

The phrase “child labor” rarely connotes a good thing. But paying your kids to help out with the family business or around the house can bring major benefits.

Your kids can build a lot of self-esteem by seeing how their efforts are putting money into their young bank accounts. And it will give them clear insights into whether the family business will be a place they’ll want to build a career after college.

And for you, their employer, the tax breaks can be significant. Recent changes in the tax laws merely strengthen the case for turning your business into a family affair.

Up to a certain point, paying your children can lead to a lower overall family tax bill. That’s because children are typically in a lower tax rate bracket than their parents. And that allows for the shifting of income from a higher tax rate bracket to the children’s lower tax rate brackets.

Also, an employing parent doesn’t need to withhold or pay Social Security or Medicare tax on a child under age 18 or pay federal unemployment tax on the wages of a child under the age of 21.

To be clear, we are talking about “earned income.” This includes wages, tips, and other amounts received as compensation for personal services, but doesn’t include corporate distributions of earnings and profits.

Here’s where the new tax laws come in. In 2018, the standard deduction was raised from $6,300 to $12,000. That sharply increases the amount of earnings dependent children can receive before being subject to federal income tax.

Calculating the tax savings are simple. Figure out your combined tax rate among federal, state and local income taxes. Multiply that by $12,000 (or whatever amount you pay your child), and that’s the amount you’ll save. For a person in the 40% combined tax bracket, that’s a savings of $4,800.

A few last points to consider. Children with income of more than $1,050 will have to file a tax return. Also, a child’s investment income (i.e. unearned income) is subject to a different set of tax rules. That investment income may be smartly deployed in a “529” college savings plan. Talk to your local fee-only financial advisor to learn more about that.

Beyond the tax benefits discussed here, earning money in your youth can become a powerful motivator later in life. I stocked supermarket shelves and worked as a valet at a country club. The things I bought that that money were especially cherished, and gave me a great sense of accomplishment. And it has been a motivating factor in my career ambitions ever since.