Q: Should I start a business so that I can take losses that'll reduce my tax bill and allow me to pay my children a salary?
A: The short answer is No. This advice has been all over YouTube, TikTok and the twitterverse, so let's talk about it. Businesses are established to make money. That doesn't mean that businesses don't ever experience losses. That just means that their intent was to earn a profit, and eventually they will.
Secondly, the IRS can determine that your business, which consistently experiences losses, is a hobby. The IRS states that an activity is presumed for profit if it makes a profit in at least three of the last five tax years, including the current year. This means that after three years of consecutive losses, the IRS could rule that your business is a hobby and at that point, they can prohibit you from claiming your business losses on your taxes.
Thirdly, you'd need to make money in order to pay your children a salary... no real business = no money earned = not able to pay a salary.
If you are considering starting a fake business to deduct fake expenses, please reconsider. The IRS has significantly increased its audit efforts, especially after the fraudulent claims for PPP and EIDL, and these things always cost more in the end.
Perhaps one of the most underutilized tax strategies by small business owners with families today is paying your children for working in the business. However, if it’s not processed properly on the ‘books’ and ‘tax return’, it can be an audit risk and frankly more of a pain than raising the kids (well not really).
If you have a child under the age of 18 that’s able to work in the business in some meaningful capacity, and you operate your business as a Schedule C, sole proprietor or as a spousal partnership, you absolutely need to consider having that child on your payroll. Why?
First, neither you nor your child would pay payroll taxes on the child’s income.
Second, with a traditional IRA, the child can avoid all federal income taxes on up to $18,400 in income (this assumes up to $12,550 of wages and IRS contributions of $6,000 for 2021). If you operate your business as a corporation, you can still benefit by employing the child even though both your corporation and your child will pay suffer payroll taxes.
Things to Note: You still need to abide by state labor laws (so if your state law requires that minors are at least 14 years old before working, and can only work 20 hours per week, then you need to operate within those guidelines). Your child must also actually be performing work (and able to work). Has your 16 year old already been helping with filing papers, following up with clients and other administrative tasks? Then this is a great opportunity to pay them wages that are commensurate with their job description (versus tossing random amounts of cash their way). Is your 2 year old capable of typing memos? Absolutely not, and this won’t pass the sniff test, so we certainly wouldn’t recommend that.
If you’re serious about starting a legitimate small business, we know charting in unfamiliar territory can be daunting and discouraging. ASE Group is here to hold your hand every step of the way and help you make those difficult decisions. Did you know that applications to start a new business hit 5.4 million in 2021 setting a new record? Pretty crazy, right? If you’re one of the 5.4 million people who recently started a business, or have been at it for years, and want to learn more about hiring your children in your business the right way, let’s talk.