Hiring Relatives Will Become More Attractive

 In Small Business

As of this writing, Congress appears to be focusing on issues other than income tax. If Congress doesn’t make any changes  this year, tax rates will rise across the board. In another possible scenario, one favored by President Obama, tax rates will rise only for high income taxpayers. (See the article “Higher Taxes Are Likely, But Perhaps Not for Everyone” in the May 2010 issue of CPA Client Bulletin.) Either outcome would make income shifting more attractive than it has been in recent years. As the spread between the highest and lowest tax rates widens, families will enjoy more tax savings by shifting income from high income parents to lower income children or grandparents.
If you are self-employed, a professional, or the owner of a small company, you may have the best opportunity to save on taxes by shifting income. This could be the case if you are in a position to hire lower income relatives, such as your children. If you pay your kids a fair wage for work they actually do, you or your company can deduct those payments and save tax at rates up to 35% in 2010. You should avoid paying relatives more than you’d pay other employees for the same tasks, however, because the IRS may disallow deductions for excessive compensation.
Meanwhile, your children may be able to receive tax-free income. In 2010, the standard deduction can shelter up to $5,700 of earned income from tax. Additional earned income will be taxed at 10%, up to the upper limit of the 10% bracket: $8,375 of taxable income in 2010.
Example: Amanda Perkins is a self- employed consultant. She files a joint tax return with her husband; together they are in the 35% tax bracket this year. Amanda hires her teenage son, Brett, to handle her office computer systems, run work-related errands, and so on. Brett works 500 hours this year, and Amanda pays him $7,500 at $15 an hour.
Brett owes no income tax on the first $5,700 of earnings, thanks to the standard deduction. On the remaining $1,800, he only owes $180 at a 10% rate. Thus, Amanda has reduced her tax obligation by $2,625 (the $7,500 she pays Brett times her 35% tax rate), and Brett only owes $180 in income tax.
All in the family
If you are in a position to hire your children, you also may be able to hire your retired parents. Again, you might save tax in a high bracket while your parents owe little or no tax on the money they earn. If your parents need extra income after they are out of the work force, hiring them can be a tax efficient way to provide support. Your parents also may benefit from the ongoing mental activity and socialization of continuing to work part time.
As previously mentioned, your children can offset earned income with a standard deduction of $5,700 in 2010. Your parents may get an even greater standard deduction. For married couples, the standard deduction is $11,400 in 2010. Each spouse who is age 65 or older gets an additional $1,100 standard deduction. Thus, if your parents file a joint return, and are both age 65 or older, their standard deduction for 2010 would be $13,600. If you hire a parent age 65 or older who files as a single taxpayer, he or she would have a standard deduction of $7,100: $5,700 plus an additional $1,400 for reaching age 65.