Last week, I had a talk with RB40Jr on the way to school. I reminded him that I have a blog and asked if he’d like to work for me. I could pay him to use his photo on Retire by 40 and also for whenever he takes a good picture that I can use. He’ll be a child model and staff photographer for us. RB40Jr enjoys taking photographs and I want to encourage him to keep at it. I asked how much he’d like to get paid for each picture I use. His answer was “How about $1?” Wow, that’s cheap. However, I told him I’ll pay him $100 per photo. I explained that I’ll put the money in an investment account (Roth IRA) and he can’t get it until he’s older. RB40Jr said okay. Alright, we’ve got a deal. Now I just have to write up a contract and finalize the details. Why am I hiring our kid as an employee? We’ll go over the benefits and then see if they outweigh the negatives. Read on…
The benefits of hiring your kid
There are 3 big benefits to hiring your kid. Let’s go through them one by one.
- Teach your kid about personal finance. Personal finance education is so important, but many young adults are woefully under educated about how to run their finances. Most schools don’t have courses on personal finance. Even if they do, most kids aren’t interested in it anyway. It’s up to the parents to teach their kids the basics. My parents taught me to save, but they didn’t know much about investing. I had to figure out a lot of it on my own. Hiring RB40Jr will give us a chance to teach him how to earn, save, invest, spend mindfully, and more. This will help him prepare to face the real world.
- Tax savings. This April, I’ll have to send the tax men over $10,000. My blog income was higher than expected last year. That’s a good problem to have, but I want to reduce my tax liability as much as I can. Hiring RB40Jr will give me a chance to shift some income from me to him. In 2017, our last $5,000 of earnings was taxed at 60%. If I shift this to him, then he can keep the whole $5,000. That sounds good to me.
- Head start on Roth IRA. Lastly, the earlier you start investing, the better off you’ll be. If RB40Jr invests that $5,000 in a low cost index fund, it could turn into $1.5 million by the time he reaches full retirement age in 60 years. That’s the magic of time and compound interest. He’d have an amazing head start on retirement savings.
The 3 benefits are huge. They will help set up RB40Jr for a successful future. Also, the Roth IRA is tax protected so it’s the perfect vehicle for investing when you’re young. RB40Jr won’t have to pay any tax on that $1.5 million. The future tax saving will be huge what that kind of timeline.
*I first read about hiring your kid on Go Curry Cracker a while ago and I thought it was an great idea. However, the inertia was hard to overcome. The tax saving wouldn’t have been much because I made less back then. He was too small to learn about personal finance as well. In 2017, Retire by 40 made $65,388 and my tax liability shot way up. This year, it’ll be worth it to put RB40Jr on the payroll.
Hiring your kid is more complicated than I thought
There are some big benefits, but I found hiring your kid is not straight forward process. I can’t just pay RB40Jr $5,000 and call it good. The IRS is involved and this means a lot of rules and paperwork. Let’s try to go through the complications one at a time. Feel free to skim these because they will get a little dry. The tax code is ridiculously complicated.
*I’m not a tax expert so I might have missed something. If you’re thinking about hiring your kid, you probably should consult a good tax professional.
1. You need to have a legitimate and profitable business. A business owner can hire and pay their child. This is part of business expense. Retire by 40 is a single member LLC (taxed as a disregarded entity) and I file the schedule C with my taxes. The business needs to be profitable as well. It’s a bad idea to create an unprofitable hobby business to shift some income to your child. This is a red flag for the IRS. (You can hire your kid if you don’t have a business, but that’s also very complicated. Let’s skip it and focus on business this time.)
2. Avoiding social security, unemployment, and Medicare taxes. If you look at your paychecks, you’d see these taxes that your employer pays. Fortunately, there is an exception for hiring your kid. This is from the IRS under family help.
“Payments for the services of a child under age 18 who works for his or her parent in a trade or business are not subject to social security and Medicare taxes if the trade or business is a sole proprietorship or a partnership in which each partner is a parent of the child. Payments for the services of a child under age 21 who works for his or her parent in a trade or business are not subject to Federal Unemployment Tax Act (FUTA) tax. Payment for the services of a child are subject to income tax withholding, regardless of age.”
Whew, it looks like we’re good so far.
3. Avoiding income tax withholding. I don’t want to withhold federal income tax. It will complicate my business accounting because I don’t have to do it now. This one is confusing for a dependent because they can’t claim their own exemption. From what I understand, dependents don’t have to pay any federal income tax if they make less than the standard deduction. That’s $12,000 for 2018. In any event, I don’t have to withhold income tax this year because RB40Jr can claim the exemption in the W4. Here is line 7 in the W4.
I claim exemption from withholding for 2018, and I certify that I meet both of the following conditions for exemption.
Last year I had a right to a refund of all federal income tax withheld because I had no tax liability, and
This year I expect a refund of all federal income tax withheld because I expect to have no tax liability.
4. Avoiding self-employment tax. This one is somewhat tricky. I have to put RB40Jr on the payroll as an employee and issue a W2 to him at the end of the year. I also need to send his W2 and a W3 to the IRS. The easier alternative is to hire him as an independent contractor and file a 1099 for him. This is a bad option, though. Independent contractors have to pay self employment tax. All those taxes we tried to avoid above will have to paid when he files taxes.
5. Kid needs to be a legitimate employee. To be legitimate, we need to create a contract for RB40Jr and also keep very good records. I’m going to pay per photograph so it shouldn’t be difficult to keep track of the posts. If I pay him per hour, then we’d need to keep a time sheet. You can’t hire kids to do chores around the house. They need to work on business related tasks. He’ll need to fill out the W4 and I9 forms. The business will need to file a W2 and W3 with the IRS for this.
6. Reasonable pay. The business also needs to pay the kid a reasonable rate. I can’t just say I’ll pay him $5,000 for the year. This one is tricky because rates are all over the place for child model and photographer. From my research, an amateur photographer can charge anywhere from $25 to $150 per photograph. A professional can charge much more. I think $100 per photo is probably too high at this point. I’ll set the rate to $50 per image that I use on Retire by 40 and $10 per image I use on social media. That sounds reasonable to me. Here is a really good reference page on how much photographers should charge.
7. Individual 401(k). Another issue is my individual 401(k). I love my i401(k) and I want to keep contributing to it. However, a business must treat all employees the same. Currently, Retire by 40 contributes 25% of its income (after self employment tax) to my i401(k) as employer contributions. If I hire a full time employee, the business will need to do the same for him/her. Also, I’d have to change to a different plan because the individual 401(k) is only for one person. Fortunately, a part time employee who works less than 1,000 hours per year can be excluded. Okay, it looks like I can keep my i401(k) plan with no change.
8. RB40Jr should file a tax return. All dependent children who earn more than $6,350 of income in 2017 must file a tax return with the IRS. I’m pretty sure RB40Jr will earn less than that so he doesn’t have to file a tax return. However, it’s probably best to file one for him so this looks legitimate.
9. I probably need help from a tax expert. Currently, I do my own business accounting and DIY my taxes. This whole thing is very complicated and I’ll probably need help from a good tax professional.
I’m worn out
Whew, I am beat. Is this really worth it? I don’t know. I already spent many days researching this whole topic and my head is about to explode. The rules are confusing and the information scattered. Why are there so many exceptions?
It looks like we’re okay and I don’t have to make many changes to the business to hire RB40Jr. Basically, I want to make sure we do it right before going ahead with this. The IRS has gone to court over this and they won some and lost some. I’d rather not have to hire a lawyer, though. That probably will wipe out any tax saving we’d get and then some.
I’d love to hear more from someone who has done this. Did I miss anything? Now, we just need to work with RB40Jr to stop sticking his tongue out…
Come back next week to read more about my i401(k). It is worth over $175,000 after just 5 years. I think that’s really good.
For 2018, Joe plans to diversify his passive income by investing in US heartland real estate through RealtyShares. He has 3 rental units in Portland and he believes the local market is getting overpriced.
Joe highly recommends Personal Capital for DIY investors. He logs on to Personal Capital almost daily to check his cash flow and net worth. They have many useful tools that will help every investor analyze their portfolio and plan for retirement.