Strategy: Put your teenager on the payroll. That can have an immediate impact on your family’s 2006 taxes. And, if your child continues working in this capacity, he or she will be eligible for other benefits.
In fact, this strategy makes even more sense if you’re facing unanticipated “kiddie tax” problems this year.
Here’s the whole story: To the extent that the unearned income a child receives exceeds an annual threshold ($1,700 for 2006), the excess is taxed at parents’ top tax rate. So, your family may be penalized if you’ve set aside funds in your child’s name to pay for college or other expenses.
Prior to this year, this harsh tax rule applied only to children under age 14. Under a new tax law change, the kiddie tax now extends to children under age 18. In other words, the kiddie tax applies for four more years of your child’s life. Plus, the change takes effect in the 2006 tax year.
At least you can reduce the resulting tax by keeping the child’s unearned income on the low side. At the same time, your child can pull down wages from a job without kiddie-tax consequences. Reason: The kiddie tax applies only to unearned income, not wages.
If possible, allocate some of your take home pay to your child. By shifting amounts that would’ve been taxable in your high tax bracket to your child’s lower tax bracket, you’ll cut the overall family tax bill.
Plus, your child could qualify for additional benefits, as any employee would, including:
- Health & life insurance.You can cover your child’s health under a group plan, which is 100% tax-free. Also, the first $50,000 of group term life insurance coverage paid on behalf of your child is generally tax-free.
Bonus: The premiums your business pays are tax-deductible.
- Retirement plans. Your child may be eligible to participate in a 401(k) or other qualified retirement plan. Although withdrawals generally aren’t allowed before age 591/2 without a 10% penalty, the funds accumulate on a tax deferred basis.
- IRAs. Once your child reaps earnings from a job, he or she can sock away up to $4,000 in a traditional or Roth IRA. Since your child’s income is low, he or she can deduct the contributions to a traditional IRA on his or her personal return. Contributions to a Roth IRA are never tax-deductible, but the funds may eventually be withdrawn tax-free.
- FICA and FUTA. If you employ a child under-age 18 in your sole-proprietorship or husband/ wife partnership business, the earnings are exempt from FICA tax. That exemption also applies to FUTA tax until your child reaches age 21. Those payroll-tax breaks can represent significant tax savings for a parent who is self-employed or a partner in a husband/wife partnership.
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