Children Can be Good Tax Planning Tools

Whether trying to fund college for your child or just general tax planning, a parent in business has an extra opportunity to save some big taxes while teaching their child(ren) some work ethics. Consider Internal Revenue Code Sec. 3121(b)(3)(A). In summation, a mother or father may pay their child a “reasonable” sum for working in the parent’s self-employed business (not an incorporated entity) and, if the child is under 18 years, there is no payroll tax (defined basically as Social Security and Medicare taxes) on these wages.

Further, the additional planning opportunity is based on the fact the payment to the child is “earned income” to the child, which means the child gets a $12,400 U.S. standard deduction (in 2020). This means the first $12,400 paid to the child is free of all income taxes. The fact that the parent and child do not pay the payroll taxes the family has shielded an extra $12,400 from taxation, per eligible child. If a self-employed parent is in the 22% federal income tax bracket, coupled with the 15.3% of payroll taxes normally required on wages, there is about a 37% tax savings on these wages paid to your child, as this amount of wages is fully deductible to the parent’s business.

And with many people being home with their children during the COVID-19 pandemic, this would seem like a good a time as any to train and monitor your child in a viable business environment.

So, have your child save this money for their college fund, etc. This money does not need to be put in a 529 plan to be shielded from taxation; so, it is available, without penalty, should the child need it for school or otherwise, at a later date.

Note, the payment to the child must be for legitimate work relating to the business which could be filing, (manual or computer), schedule maintenance of business clientele and other mundane business chores. The work must also be age appropriate. Also consider, if your business needs to advertise, then the use of the child’s likeness would also qualify if within the legitimate scope of the business.

You may also use the money paid to your child to establish an IRA account on their behalf, which is a great way to help your child focus on the future and get a head start on lifetime financial planning. For 2020, the IRA for a child would be $6,000 which, if applicable, could raise the deductible amount you pay your child to $18,400. Or, if a state like NY, which has a much lower standard deduction for a child ($3,100 for 2020), you would then shield $9,100 from taxation in New York.

And lastly, presuming the parent is still providing over half the support for their child all the tax exemptions and tax credits are still fully available to the parent.

Supreme Court-sales tax

Photo attribution: David Dugan/Wikimedia Commons.

Due to a 2018 U.S. Supreme Court case (Wayfair v S. Dakota), internet retailers can now be required to collect sales tax. The tough part is interpreting what this all means; how states will apply the right to tax internet retailers (e-tailers).

1. Some important things for businesses. Registration. Before a business can collect sales tax they must officially register to seek permission to collect sales tax within the state(s) they conduct business within. If a business merely collects taxes prior to registration there is usually large penalties. NY State-as an example-can impose a $10,000 fine.

2. Acquire proper software if you sell via internet that will track sales in multiple locations. You must, however, research to be sure the product/service you are selling via the internet is subject to tax in various jurisdictions. Charging tax when not required could create problems with your customers and certainly put you at an economic disadvantage. So, do not presume all states treat all products/services the same regarding sales tax applicability.

3. Of course, do not jump into registering in all 50 states to collect sales tax, just because you are an e-tailer. The South Dakota law reviewed by the U.S. Supreme Court had a de minimis exemption in the law; under $100,000 in annual sales and less than 200 transactions in the state. Simply stated; if you did not meet those limits you are not required under the South Dakota law. to collect any sales tax. This does not mean other states must follow suit and exclude the same amounts but likely a drastic change of these exemptions would cause a state law to be unconstitutional because of the “burden on interstate commerce”, which the Courts are always concerned about.

4. An income tax requirement is now born in all these states. In addition to registering for sales tax in required states an internet e-tailer would need to register with that same state’s Department of State. This is required so the business has the legal authority to conduct business in that state. Consequently, if you are doing business in any state you are also required to file an income tax return, whether you are structured as a Corporation or Limited Liability Company. This of course truly increases the burden on internet companies not only in tax payments but in administrative costs for filing multiple income and sales tax returns.

5. So take a deep breath and conquer each item methodically. And hope that maybe Congress will intercede. Congress may be able to legislate this away and possibly create a uniform sales tax rate for e-trailers throughout the country and disburse the collections based on a formula of population or on the volume of sales from within each state. This would, however, not eliminate the need to file income tax returns in multiple states, but could eliminate the sales tax registration in the particular states.