If you or your spouse operates a business as a sole proprietorship or partnership, you may be able to earn business income deductions by employing your child. In this case your child may have to file a personal income tax return and claim the standard deduction to reduce his tax obligation.
Sole Proprietorship
As a sole proprietor, your business can employ your child and enjoy certain tax benefits. Wages are a deductible business expense that you may report on your Schedule C tax form, Profit or Loss from Business. An additional child-specific benefit also exists. You do not have to withhold Social Security and Medicare payroll taxes from income paid to your own child. This also allows your business to retain the employer's portion of these taxes as well as the funds traditionally paid for federal unemployment taxes. As long as your child's income does not exceed the amount of her standard deduction, income tax withholding remains unnecessary as well.
Partnership
If your business operates as a partnership, your business can employ your child and enjoy the same tax benefits as a sole proprietorship. However, both partners in your business must be the parents of the minor child. If your partner is a friend, associate or another relative, the benefits do not apply.
The Child's Standard Deduction
At the time of publication, the maximum standard deduction for a person filing as single is $5,700. This means that your child could earn up to $5,700 in income from your business without accumulating an income tax bill on the earnings. If your child's earnings are less than $5,700, you must use The Standard Deduction Worksheet for Dependents included in IRS Publication 929, Tax Rules for Children and Dependents, to calculate her deduction. If your child files her own return then she cannot claim herself as a tax exemption if you can claim her as a dependent on your return.
Funding an IRA
When your child's income exceeds his standard deduction by a small amount, he can place the excess money in an IRA to offset the additional income with a tax deduction. The instruction booklet for IRS Form 1040 features an IRA deduction worksheet for calculating the maximum deduction for IRA contributions your child is allowed based on his earned income and tax filing situation.
