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Hey there, fellow real estate investors, FIRE enthusiasts, and tax aficionados! Welcome to "Real Estate is Taxing" – your go-to weekly podcast for all things real estate taxes, hosted by Natalie Kolodij, EA- Real Estate Tax Strategist and dry humor extraordinaire.
Each week, we're breaking down complex tax topics into bite-sized, understandable explanations, with no regard for how many obscure references it takes to get there.
Speaker: Welcome to Real Estate is Taxing,
where we talk about all things real estate
tax and break down complex concepts into
understandable, entertaining tax topics.
My name is Natalie Kalady, I'm
your host, and I am so excited
that you've decided to join me.
Microphone (Shure MV7): One of the
most common driving factors I hear
from many real estate investors,
business owners, et cetera.
For why they got into the
business to begin with.
Is to create a lifestyle that would allow
them to spend more time with their family.
And create future wealth
for their children.
Now I myself am out here living
this childless millennial lifestyle
where all of my time and money I
can spend on whatever I would like.
But I realized that there are many people
who went a different route and have kids.
Those who do have children, especially
those with a business have really taken
to the idea of teaching their kids
responsibility, fiscal responsibility,
teaching them about money as a whole and
wanting them to build these same skills.
That allowed them and their business
to create this lifestyle and
this opportunity for their kids.
Whether you are a landlord, a small
business owner, a large business
owner, or a legal or tax professional
who works with any of the above.
You are going to want to listen
to today's episode because this
can be a game changer for you.
Today, we are talking about how
someone can employ their children.
In their business.
This is a fantastic strategy
to save money, to help them
prepare for retirement.
To teach them responsibility and ethics.
There are countless reasons that this
is an incredibly popular strategy.
However, it is also a strategy that
has a ton of misinformation available.
So today we are going to talk through.
The requirements for
employing your children.
The benefits of doing so, and the
reasons you need to avoid some of the
common misconceptions about doing this.
As a starting point.
The first benefit to employing
children in your business.
Is giving an opportunity to have
them grow up, learning the business.
It'll help teach them
about responsibility.
It'll give them that structure.
And if the plan is to have them take
over one day, It really helps bring
them into things at a young age.
Looking more to the
financial side of things.
There is.
A fantastic benefit in the tax
code that allows parents to employ
their children who are under 18.
In their business.
And not have to pay
payroll taxes on the wages.
They pay them.
So this offers a really
unique opportunity.
When we take this idea.
And pair it with the secondary fact.
That someone who earns less than the
standard deduction in a year is not
required to file a tax return and
they won't have any taxable income.
What we have created is a situation
where a parent can pay their child
up to the standard deduction for
doing work in their business.
And then the child, as long as that
is under that standard deduction
does not have to file a tax return
and does not have to pay any taxes.
So this has created.
A fantastic opportunity to
accomplish several different things.
The first item that this
provides is a benefit.
Is the opportunity to shift income
from the parents higher tax bracket.
Over to a 0% tax rate.
For being under the child's income.
The next opportunity.
Is allowing children to fund a
Roth IRA at a much younger age
than they would typically start.
There is a huge time value of money.
And getting to begin funding
that while they're still little.
I can really have a tremendous
benefit in the longterm.
Microphone (Shure MV7)-1: With
these undeniable benefits.
It's no wonder people are all encouraging.
Every business owner they
know to employ their kids.
So we are going to start off today's
episode by walking through the advantages
of employing the strategy, but you're
going to want to stick around to the
end because I am also going to walk
through the common mistakes and why
they can be costly and end up blowing
up this whole strategy for a taxpayer.
As an initial benefit.
There can be a substantial
amount of tax savings.
Based on someone employing their children.
This is because we can pay each
child up to the standard deduction
for doing work for the business.
For 2024, that amount is $14,600.
So if someone has two children that is
close to $30,000, that we can potentially
reduce their taxable business income by.
And we're effectively shifting it over
to a 0% tax rate under the children.
If the parents are going to be.
At say a 22% effective
tax rate for the year.
Reducing their income by $14,600.
Effectively results in a
savings of around $3,000.
So if they have multiple children and
were employing multiple children and
shifting this amount more than once.
That tax savings just
increases from there.
So the first key benefit is
tax savings for employing
your children in the business.
By shifting income from the
higher tax bracket of the adults.
Over to the tax-free rate of the children.
The next benefit that
this puts into place.
That to me, Is, I would
argue the greatest benefit.
Is having earned income will allow
that child to fund a Roth IRA.
Now the earlier someone
can start investing.
The more they will have
at retirement, right?
We've all seen the charts that tell you
how much you need to contribute per year.
At what age to end up with $1
million at retirement, et cetera.
The younger you start the
less it costs overall because
of the time value of money.
So if a child starts funding a Roth
IRA account, when they're eight or
nine years old, instead of starting
when they're 18 or in their twenties,
when they get their first job.
This is going to allow them to have
a tremendous advantage over where
the average person starts off when
it comes to retirement investing.
If a child is able to put.
Around $6,500 a year into a
Roth IRA starting at the time.
They're eight years old.
By the time they're an adult.
Once they hit 18, they should have
close to six figures in that account.
That is more than many people into their
twenties have saved for retirement.
So having the opportunity to
start that retirement account
for your children early.
Is such a huge advantage.
And that can't be done without
them having earned income.
These two things combined.
Create a fantastic benefit.
And there's really not many downsides.
As long as the compliance
is done correctly.
So let's move on to the less fun part of
what is required to do this correctly.
So it doesn't end up
falling apart for you.
The first requirement.
Is that you are going to
be employing your child.
So what this means.
Is that they have to actually be an
employee and treated in the same way the
business would treat any other employee.
This means they have to actually
do work for the business.
That child cannot be doing household
chores or other around the house tasks.
The child also needs to
actually do the work.
You can't just say you're paying them for
X number of hours that they didn't do.
It has to be treated the same
way as any other employee.
They also need to actually
be paid for the work.
You can't just say you're paying them.
You still have to actually pay them.
The way you would pay any other employee.
And finally.
They have to be paid.
A reasonable wage for
the work they're doing.
The same general amount that you
would pay any other employee.
The reason I like to emphasize this part.
Is there is a lot of gray
area in people's minds.
So what these facts really emphasize.
Is, you have to treat them as though
you hired any other person off the
street to do this work for you.
So what that means?
Is if the minimum wage for where you
live is $15 an hour or $17 an hour.
And the role you're hiring them to do the
tasks they're going to complete are really
simple things that someone who has a
pretty minimal skill set as a child would.
Are able to complete.
Then you need to be paying them
close to that minimum wage.
You cannot just choose to pay your
ten-year-old a hundred dollars
an hour when you could have
hired any other employee to do
those same tasks for $20 an hour.
So you have to pay them a reasonable
wage for the work they're doing.
And they actually have to do the work.
And it actually has to be in the business.
The next common mistake that
creates a ton of headaches.
When this comes up in court cases.
Is not having valid documentation.
And reasonable tracking the way a
business would for another employee.
So at the start of the episode, we talked
about the benefit of getting to move
up to $14,600 over to being tax-free.
We just covered the fact that you have
to pay your child a reasonable amount.
So if you are paying them $17
an hour, That equates to working
over 400 hours during the year
to reach that $14,600 amount.
If we split that up across 52 weeks.
That's around eight hours a week
that the child would have to work.
This may or may not be reasonable.
Depending on their age, depending
on the business, et cetera.
It doesn't have to be spread
evenly across all 52 weeks.
What we see a lot is where children
are on summer break, they'll work
more hours, and then it pulls
back while they're in school.
But just be mindful that if a child is
10 years old, There's not a good chance
that they are working eight valid hours
of work every single week for a business.
So it does have to be.
All reasonable and justified.
One of the most common reasons.
This is disallowed when it's looked
at, by the IRS and in court cases.
Is because they just select
an amount to pay the children.
And there's no.
Justification for how they got there.
They're just choosing $14,000
because they know it's the max.
There is no justification for the tasks
they're doing the hours they work, how
old they are, their skillset, et cetera.
So that is the first very common mistake
that you are going to want to avoid.
Is do not just pay them the
maximum, make sure you are
actually paying them for work.
They do at a wage that
is reasonable for work.
They do.
And that you are keeping track of it.
Even though they are your child.
Even more so because the hair, your child.
You should have them keep a time
log of their hours worked the
same way you would have any other
employee clock-in and clock-out.
The next mistake that we
hear about pretty frequently.
Is that you can do this no matter
what, that anyone can pay their
kids and not pay payroll taxes.
On those wages, they're paying
them and that's as deep as it goes.
There is a limitation to what type
of entity can do this strategy
while avoiding payroll tax.
If the children are paid from a business.
That is operated as a sole proprietor.
A single member, LLC.
Or a partnership, a multi-member LLC
where the only partners are the parents.
Then they are able to pay
those minor children without
incurring any payroll taxes.
However, if they are paying the
children out of an S-corporation.
Or a C corporation, they will
still be subject to payroll taxes.
So it's incredibly important.
To make sure that before you employ
this strategy, You understand the full
tax impact it's going to have on you.
As well as the filing requirements
and remission requirements for
sending in self-employment tax,
that you might be subject to.
So don't just assume
because they're your kids.
There won't be any taxes
owed for payroll tax.
It is going to depend on
your business structure.
And lastly what I would argue.
Is probably the most common mistake
that comes up with this strategy.
Is two part.
People are either under the
assumption that they do not
need to provide their children.
With any kind of a form.
To document their pay.
Either a W2, 10 99, et cetera.
There are people who think
nothing is required to be filed.
Because we know the child won't
have to file a tax return.
So why do we give them a form?
If we know they're not going
to have to do anything with it.
Well, this is because whether an
employee has a filing requirement.
And whether you as an employer
have a legal requirement to file
a form are completely unrelated.
So even if that is your child,
And, you know, they won't need
to take that form and do anything
with it that doesn't matter.
You as the operating business still
have the same exact requirements.
To submit any required
documentation and forms.
As you would, if you were
employing a total stranger.
So you do still have to
issue quarterly reports.
So you still do have those
requirements as the employer.
Part two to this misconception.
And this I think is what I see the very
most often that creates the biggest issue.
Is many people believe that they
should or can, or the correct way.
Is 2, 10 99, their children.
I don't know why this is thought
to be the best way to do this.
I'm assuming because it's
less work on the employer.
Oh, just issue them a 10 99.
That's one form.
Instead of having to file
payroll reports monthly or
quarterly or annually, et cetera.
However.
If you remember at the beginning of the
episode, we said that a child can make
up to the standard deduction of $14,600
and not have to file a tax return.
That is not the case.
If someone has self-employment income.
And someone who receives
a 10 99 for work, they do.
Is self-employed.
If someone has self-employment income.
They need to file their own tax return.
If they earn any more than $400.
So if you have paid your
child, $12,000 during the year.
And then at the end of the year,
you issue them a 10 99 and you
think nothing has to happen.
That's incorrect and now they
would need to file their own
tax return to report that 10 99.
And they are going to have
self-employment income.
A schedule C business.
Subject to self-employment tax.
So at the surface issuing a 10
99, instead of a W2 is going
to create a much worse outcome.
For no reason, it's just
going to make things worse.
In addition to this.
The IRS has very specific requirements.
With who can be classified as
a 10 99 independent contractor.
Versus who is a W2 employee.
So if we read over those requirements
for who can be a 10 99 contractor.
The IRS notes that the general
rule is that an individual
is an independent contractor.
If the payer has the right to control
or direct only the result of the work.
And not what will be done and
how, and when it will be done.
You are not an independent contractor.
If you perform services that can be
controlled by an employer, what will
be done and how it will be done.
This applies, even if you
are given freedom of action.
What matters is that the employer has
the legal right to control the details
of how the services are performed.
Do you think.
That a ten-year-old.
Is going to have all of the freedom
of operating their own business.
Outside of the end result.
Do you think a parent is going
to tell a ten-year-old your
task, what we need you to do?
I'll pay you $5,000.
To go completely clean this
property in between tenants.
And you are actually going to do this
for all of our short-term rentals.
Use, whatever products you
want go whenever you want.
Take as long as you want, do whatever
systems you want to use, you choose how
any of this happens, but we're paying
you $5,000 to clean all of our rentals.
No.
The parent is probably going to go
to a rental with their ten-year-old
and say, the broom is over there.
Please sweep for me.
Or you wiped down everything in
this bathroom using these products.
It child.
Is likely not going to meet
the requirements to be a 10
99 independent contractor.
This strategy is called employing
your kids because you literally
have to employ your kids.
So not only.
Will they not qualify to be
treated as a 10 99 contractor?
In doing so.
You are creating a worst tax situation.
Then, if you had just done it correctly
and treated them as a W2 employee.
For the work they do.
Additionally.
One of the risks of incorrectly paying
someone as a 10 99 contractor when
they should have been an employee
based on all facts and circumstances.
Is if this has ever audited.
And the IRS.
Reclassifies that to W2 wages, which is
what it should have been the whole time.
You are now going to be
subject to a whole slew.
Of penalties and interest.
For not having paid payroll reports
on time, not having submitted
the tax on time, et cetera.
Your child who is employed by
your business as an employee.
This means that you should do.
All of the standard requirements
you would do for any other employee.
You are going to want to
have an employment contract.
You are going to want
them to track their time.
You are going to have to
file those payroll reports.
And you are going to want to issue
them a W2 at the end of the year.
Even if they're not doing
anything with that form.
Even if you don't owe any payroll tax.
None of that removes the requirement.
Have you as a business to
still file those reports.
And that's the correct way to do this.
The final item that we spoke
about as a benefit earlier.
Was funding that Roth IRA for your
children and how much of a huge benefit
that is because they have this time.
To build the value of
their retirement accounts.
Part of that requirement.
Is them having earned income.
If.
You are not issuing them any forms or
if you're incorrectly issuing them a
10 99 and not following, et cetera.
If they don't have a tax return filed
showing they have earned income.
And.
If you didn't issue any kind
of formal documentation.
Reporting correctly, their earned income.
There is no way to prove
that they had earned income.
Really?
You didn't legally follow
the steps to report it.
If that is ever looked at by the IRS.
And those fundings that
go into their Roth IRA.
Our disallowed.
That's going to blow up the whole plan
and create a whole slew of issues for you.
To recap today's episode.
We covered the benefits.
Employing your children allows you
to shift income from your higher
bracket as an adult over to being 0%.
Taxable to them.
You can potentially pay them up to
the standard deduction each year.
They won't have to file a tax return.
They won't have to pay tax.
And they can start funding
a Roth IRA with those funds.
From the age where they
start having earned income.
Giving them a huge head
start on retirement.
The risks and cautions.
You do have to actually pay
them for work in the business,
not private household chores.
They need to actually do the work.
They need to be paid for the work.
They need to be paid a
reasonable amount for the work.
You are also going to want to
have an employment contract.
Have them have a time clock where
they're tracking their hours and you
as the employer should still file all
of the required payroll reports and W2.
Even if there's no tax
owed on any payroll taxes.
The last warning is you do not
want to issue the child a 10 99.
This is incorrect reporting.
They don't qualify to be a
10 99 independent contractor.
If this is ever looked at
and the IRS, reclassifies it.
As wages.
You will have a ton of
penalties and interest.
And.
If someone receives a 10 99.
Then the amount they can earn
before having to file a tax return.
Drops down from $14,600 to $400.
Then you are likely to not file a
tax return for the child, because you
didn't know, you had to, that's going
to result in late filing penalties.
It opens up an entire arena.
Of penalties and issues and headaches
for doing this the wrong way.
Employing your kids is
a fantastic strategy.
Anyone who has children and has either
a business or rental properties.
Should look into doing this.
Just do it the right way, set them
up as an employee and don't try to
default to moving over the maximum.
You can do it correctly and set them up
for reasonable earnings year to year.
This can increase as they get older.
And either way, you're still going to be
in a better tax position and be setting
up your child for a fantastic advantage.
By starting to fund a Roth
IRA at a much younger age.
So as always, I hope you got
some value from this episode.
If you know, someone who has
children and has a business.
Or, you know, someone who started
implementing the strategy,
but is not doing it correctly.
Please share this episode with them so
that they can get things straightened out.
And take advantage of this tremendous
benefit in the tax code without having
risks that are sitting out there.
As always, if you're enjoying the podcast,
please give it a five star rating.
Even if you don't know someone
with kids in a business, I would
love, if you would share an episode
that you got value from anyway.
And I will talk to you next week.
Mhm.