Flip traditional income-shifting tactic on its head: Hire your parents — Business Management Daily: Free Reports on Human Resources, Employment Law, Office Management, Office Communication, Office Technology and Small Business Tax Business Management Daily
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Flip traditional income-shifting tactic on its head: Hire your parents

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in Employee Benefits Program,Hiring,Human Resources,Small Business Tax,Small Business Tax Deduction Strategies

You've probably heard that hiring your children is a great tax-saving move. Their income is taxed in their low tax bracket, and as long as you handle things correctly, your company can deduct the compensation.

But now may be the time to turn that time-honored tax technique on its head. How? Put your mom and dad on the company payroll.

By shifting your income to the older generation, you can still generate income-tax savings for the family, while your company keeps its deductions. In fact, it might turn into an even sweeter deal than hiring your kids.

Case study: To see how the strategy works, let's look at a hypothetical example: Your 70-year-old widowed mother needs an extra $10,000 to get by each year. Since she expects to earn more than $3,100 in investment income in 2004, you can't claim her as your dependent if you simply gave her the cash. Instead, since she likes to keep busy, you hire her to help with light bookkeeping in the office.

Suppose you pay your mom $12,000 a year for her services. She's in the 15 percent tax bracket, so she must pay $1,800 in tax, netting her $10,200 before other payroll deductions.

In comparison, if the $12,000 in compensation had been paid to you in your 33 percent tax bracket, you would have paid $3,960 in tax ($2,160 more than your mom would pay). Even better: You receive value for money you would have given your mom anyway.

That's not all. Being a regular employee entitles your mother to the same fringe benefits as other employees. For instance:

Health and life insurance. You can provide health insurance for your mother under your company's group plan. The coverage is 100 percent tax-free to Mom. Similarly, your company can pay for the first $50,000 of group-term life insurance coverage tax-free. Premiums paid by your company are deductible.

Retirement plans. Your mother can participate in the company's 401(k) or other qualified plan. Even though she is nearing age 70 1/2 , she can choose to postpone mandatory distributions until the year she re-retires.

Roth IRAs. While your mother can't contribute to a traditional IRA after turning 701/2 , she is still eligible to contribute to a Roth IRA. The contribution limit for 2004 is $3,000, plus she can add an additional $500 "catch-up contribution" because she's over age 50. She's not required to begin lifetime distributions. The Roth IRA payouts will be tax-free if the account has been open for more than five years.

Final note: Make sure you pay your parents a reasonable amount for the services they actually perform. If your mother earns $150 an hour for filing work, IRS auditors won't buy it. Best bet: Keep your mother's pay on par with the pay of your other employees.

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