Employ Your Kid AND Save for Their Future

Unless you’ve been living in a cave for the past couple decades, you’re probably aware that the cost of your child’s education has and continues to skyrocket. You’ve probably asked yourself how you’re going to be able to pay for it or at least give them some financial assistance to do so. Like any lofty goal, you’ve got to break it down into bite size pieces and tackle it one step at a time. The bite size pieces we are talking about in this post are yearly contributions to a Roth IRA. If you own your own business, then you have a unique tax saving opportunity.

Now, in order to fund these yearly contributions, Timmy/Suzie must have earned income to the extent of the contribution. It may take a few years for this to be possible depending on the age of your kid. To get started on saving before your children are of working age, you’d probably want to look into your state’s 529 plan. You won’t get a deduction for your business, but you may receive a state tax deduction for your contribution, depending on which state you live in.

Once they are old enough to work, (which is a matter of state law, so make sure you understand those rules) then you can actually pay them up to $12,200 (in 2019) for work performed in your business without them having to pay any federal income tax (they’ll likely have a small tax bill on the state level the closer you get to $12K). There will be payroll taxes on these wages but you will be deducting all of this as wages paid by the business, so ultimately, the income tax savings will likely triple the amount of the dollars paid in payroll taxes and any trailing negligible state tax bill (assuming a combined 33% tax rate).

Now that you’ve paid Timmy/Suzie $12,200, that means they likely have somewhere around $11K to invest after paying their portion of FICA, unemployment taxes and state income taxes. $5,500 goes straight into a Roth IRA. Why a Roth IRA? Because essentially no tax was due on the income, so there’s no reason to generate a tax deduction by contributing to a traditional IRA. The Roth IRA will grow tax free. In college, your kid can pull out up to the amount of their contributions to the IRA without any tax implications. If they time their distributions well, they could end up with no tax liability on the earnings either if it’s below the standard deduction at that point in time. Or, if they get a scholarship or don’t go to college, they could just keep that account accumulating to have a solid sum of tax-free money to use for retirement.

What to do with the remaining $6,500? After all, they had after-tax money of $11K for the year. Once Timmy and Suzie keep some money for their own entertainment (they did work for it, after all), consider contributing to a 529 plan so the assets can grow without taxation upon distribution (so long as distribution are used for qualified education expenses). You’ll want to withdraw this money before Roth IRA funds since there will be zero tax implications, so long as it’s used for education. The Roth funds might be used to pay for living expenses depending on the situation.

Even if you don’t have your own business, it still makes sense to encourage your children to get out there and earn some money because you’ll still benefit from everything other than the deduction for the business. It’s time to push Timmy/Suzie out into the real world to make some coin so that they can fund the Roth IRA. Also, you can fund a 529 Plan at any time without regard to their income.

Whatever your situation is, we can help you formulate a game plan to achieve the most tax-advantaged result possible. We’ll look forward to hearing from you!

About Dark Horse CPAs

Dark Horse CPAs provides integrated tax, accounting, and CFO services to small businesses and individuals across the U.S. The firm was founded to save small businesses (and their owners) from subpar accounting and tax services and subpar client experiences. These small businesses are Dark Horses among their larger and more well-known competition. Being a Dark Horse CPA means advocating for small businesses by bringing them the tax strategies and accounting insights previously reserved for big business. Get a quote today.