Many small businesses have been hurt by the COVID-19 crisis. That's not news. Unfortunately, the virus could be around for years. Presently, the prospects for developing an effective vaccine in time to really help much are uncertain at best. Hopefully, that turns out to be wrong.
We just had this dialogue with a practicing attorney and his office manager wife who just came on board as a new client (you know who you are). Although they were not asking such, we suggested they consider hiring one or more of their children or other family members to work in their business. In this financially challenging COVID-19 era, that can be a good idea—if for no other reason than it keeps money in the family where it may be sorely needed. They did not know about the array of tax benefits that can come along with hiring a child or family member. The tax benefits can be significant. This could help their family and their practice/business overcome COVID-19-caused cash-flow challenges while also delivering favorable tax results to both the newly-employed family members and the businesses that hire them. Of course, the wages must be reasonable for the work performed.
Sole Proprietorships and Husband-wife Partnerships Can Hire Under-age-18 Children
If you operate your business as a sole proprietorship, a single-member LLC that's treated as a sole proprietorship for tax purposes, husband-wife partnership, or LLC that's treated as a husband-wife partnership for tax purposes, you can hire your under-age-18 child as a legitimate employee, and the child's wages will be completely exempt from Social Security and Medicare taxes (FICA tax) and Federal Unemployment Tax (FUTA tax).
The FICA tax exemption applies to both the employee's share of FICA tax that's withheld from his or her paycheck and to the employer's share of FICA tax. So, both the employee-child and the business come out ahead. Note that the FUTA tax exemption lasts until the employee-child reaches age 21.
You can hire an under-age-18 child part-time, full-time, or whatever works for the business and the child's schedule. Will the child go back to attending school in person in August or September, or will classes be conducted online? You may not yet know for sure, but the child's availability to work in the business may be at an all-time high in the COVID-19 era.
Wages received by your child can be used to help keep the family afloat financially. If your family is not so financially stressed, the child can use some or all of the wages to fund a college savings account or make an IRA contribution (traditional or Roth). Note that the child must have earned income during the year to make an IRA contribution. The maximum IRA contribution for the 2020 tax year is $6,000 for anyone who will be under age 50 as of 12/31/20. If your child contributes to a traditional IRA, he or she could earn up to $18,400 in 2020 without paying any income taxes ($12,400 standard deduction plus a $6,000 deductible IRA contribution).
Are the Tax Results Still Good When an Older Child Is Hired?
Yes, but if the newly-employed child is age 18 or older, his or her wages are subject to FICA tax, just like for any other employee (21 for FUTA tax). From an income tax perspective, the results are even better. For 2020, your child will owe no federal income tax on the first $12,400 of wages received from the business if he or she files as a single taxpayer and has no taxable income from other sources. That amount increases to $18,650 if the child files as head of household or $24,800 if married filing jointly. This is true regardless of the child's age, thanks to the standard deduction.
Are the Tax Results Still Good for an Incorporated Business?
Yes. If you operate a business as an S or C corporation, the child's wages received from the business are subject to FICA and FUTA taxes, just like for any other employee, regardless of the child's age. However, here's the good part. For 2020, your child will owe no federal income tax on the first $12,400 of wages received from the business if he or she files as a single taxpayer and has no taxable income from other sources. That amount increases to $18,650 if the child files as head of household or $24,800 if married filing jointly. This is true regardless of the child's age, thanks to the standard deduction.
Are Wages Paid to a Child or Family Member Eligible for the Federal Payroll Tax Deferral?
Yes. Under the CARES Act federal payroll tax deferral provisions, your business can defer the employer's 6.2% share of the Social Security tax component of FICA tax owed on the first $137,700 of an employee's 2020 wages. The deferral privilege applies to payroll tax deposits and payments that would otherwise be due during the deferral period. The deferral period began on 3/27/20 (the date the CARES Act became law) and will end on 12/31/20.
The payroll tax deferral is available to all employers (small and large alike) for eligible payroll taxes on wages paid to all employees (related or unrelated to owners of the employer), including wages paid to owners of an S or C corporation. There is no requirement to show that the business has been adversely affected by the COVID-19 crisis. Nice! The business must pay the deferred payroll tax amount in two installments: (1) 50% by 12/31/21 and (2) the remaining 50% by 12/31/22.
Is the Payroll Tax Deferral Privilege off Limits If a PPP Loan Has Been Forgiven?
No. The Paycheck Protection Program Flexibility Act of 2020 was signed into law on 6/5/20. The legislation repealed a CARES Act provision that disallowed the payroll tax deferral privilege for some taxpayers that received Paycheck Protection Program (PPP) loans that were later forgiven. So, the payroll tax deferral privilege is now fully available to businesses that also benefit from forgiven PPP loans. Good!
Summary of Tax Advantages for Your Business
Hiring a child or other family member to work in the client's business can be a smart move in the COVID-19 era. However, we strongly suggest that clients who follow through with this idea must do the following:
(1.) Pay reasonable wages for the work performed to lock in tax-saving expense deductions. Higher wages can be paid to children or family members who are teenagers or older because they can be assigned to more-meaningful tasks.
(2.) Keep payroll records just like for any other employee to document hours worked and duties performed (e.g., timesheets and job descriptions).
(3.) Issue W-2s just like for any other employee.
Oh, one last thought that did not apply to the new client virtual conference call from last week. If your business will be unprofitable this year due to the COVID-19 economic fallout, deductions for wages paid to a child or family member can potentially create or increase a Net Operating Loss (NOL) for 2020. Thanks to the CARES Act, an NOL that arises in 2020 can be carried back for up to five tax years-potentially all the way back to 2015. An NOL carryback can trigger a refund of income taxes paid for the carryback year. That can really help financially stressed businesses. Carrying an NOL back to a pre-2018 tax year can be especially helpful because federal income tax rates were generally higher in those days.
Martin H. Abo, CPA/ABV/CVA/CFF is a principle of Abo and Company, LLC and its affiliate, Abo Cipolla Financial Forensics, LLC, Certified Public Accountants – Litigation and Forensic Accountants. With offices in Mount Laurel, NJ, Morrisville, PA and Franklin Lakes, NJ. Marty can be reached at marty@aboandcompany.com or by calling 856-222-4723.
