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Member of Russell Bedford International, a global network of independent professional service firms.
To cope with inflation, the tax code requires the IRS to adjust the tax rates, standard deductions, and a variety of other tax related numbers each year. Due to the relatively low rate of inflation from 2020 to 2021 (at least according to the calculation method prescribed by law for this purpose), several categories had no change or only a slight change. The following is a summary of the most commonly encountered inflation adjustments for 2021.
The standard deduction consists of a filing status-based basic amount and additional amounts for elderly and blind filers (and their spouses). The additional amounts do not apply to dependents. The 2020 and 2021 amounts are compared below.
Added amounts for elderly and blind:
The limit on contributions by employees who participate in Sec. 401(k), Sec. 403(b), most Sec. 457 plans, and the federal government’s Thrift Savings Plan remains unchanged at $19,500 for 2021. The catch-up contribution limit for employees age 50 and over also remains unchanged at $6,500.
The contribution limit for SIMPLE retirement accounts remains unchanged at $13,500 for 2021.
For IRAs, the limit on annual contributions remains unchanged at $6,000 for 2021 and the additional catch-up contribution limit for individuals age 50 and over is $1,000. This limit applies to the combination of traditional and Roth IRAs. However, there are additional limitations that apply to both traditional and Roth IRAs.
Traditional IRA: Typically, contributions to a traditional IRA are tax deductible, unless the taxpayer is also an active participant in an employer plan. In that case, the deductibility of the contribution is phased out for higher income taxpayers. The phaseout thresholds have increased somewhat for 2021:
Roth IRA Contributions: Roth IRA contributions are phased out for higher income taxpayers whether or not they actively participate in an employer’s plan. The AGI thresholds limiting Roth IRA contributions have been increased slightly for 2021:
The amount of the estate tax exclusion for a decedent passing away in 2021 has increased to $11.7 million, up from $11.58 million in 2020.
The annual gift exclusion amount is unchanged. The first $15,000 of gifts (other than gifts of future interests in property) to any person in 2021 is exempt from the gift tax. 2021 is the fourth consecutive year that this exclusion has been $15,000.
The Internal Revenue Code allows a business taxpayer to expense, limited to taxable income from all of the taxpayer’s active trades or businesses, rather than depreciate, certain property used in business. For 2021 the maximum is $1.05 million ($525,000 for married taxpayers filing separate), up from $1.04 million in 2020. The phaseout threshold based on the cost of Sec 179 property also increased to $2.62 million, up from $2.59 million.
Each year inflation adjustments are also made to tax rate schedules. Click here to view the schedules for 2021.
The optional vehicle mileage rates for 2021 will not be released until later in the year or early in 2021. Please check back for an update.
If you have any questions about inflation adjustments for 2021, please contact Cray Kaiser today. We’re here to help!
Please note that this blog is based on tax laws effective in December 2020, and may not contain later amendments. Please contact Cray Kaiser for most recent information.
If your business engages the services of an individual (i.e. independent contractor), other than one who meets the definition of an employee, and you paid him or her $600 or more for the calendar year, then you are required to issue that person a Form 1099-NEC or 1099-MISC. This form will help you avoid penalties and the prospect of losing the deduction for his or her labor and expenses in an audit. Payments to independent contractors are referred to as non-employee compensation (NEC). Form 1099-MISC will continue to report rents, royalties, crop insurance proceeds and several other types of income unrelated to independent contractors.
Because so many fraudulent tax returns are filed right after e-filing opens up in January, the IRS requires 1099-MISCs for NEC to be filed by January 31st and will not release refunds for individual income tax returns that include the earned income tax credit until the NEC amounts can be verified. The 2020 Form 1099-NEC deadline is February 1, 2021 due to the weekend. This is also the same due date for mailing the recipient his or her copy of the 1099-NEC.
The government provides IRS Form W-9, Request for Taxpayer Identification Number and Certification, as a means for you to obtain the vendor’s data you’ll need to accurately file the 1099s. It also provides you with verification that you complied with the law, in case the vendor gave you incorrect information. We highly recommend that you have potential vendors complete a Form W-9 prior to engaging in business with them. The W-9 is for your use only and is not submitted to the IRS.
The penalty for failure to file a required information return due in 2021, such as the 1099-NEC, is $280 per information return. The penalty is reduced to $50 if a correct but late information return is filed no later than the 30th day after the required filing date of February 1st, 2021, and it is reduced to $110 for returns filed after the 30th day but no later than August 1st, 2021. If you are required to file 250 or more information returns, you must file them electronically.
Given the hefty penalties related to noncompliance, we urge you to carefully review your records for required 1099 reporting. If you have any questions about the 1099-MISC filing date, or would like us to prepare these forms on your behalf, please contact Cray Kaiser today.
Please note that this blog is based on tax laws effective in December 2020, and may not contain later amendments. Please contact Cray Kaiser for most recent information.
This time of year may have you wondering, how much do charitable donations reduce taxes? And what opportunities are there this year due to tax law changes? The good news is, due to the pandemic, tax rules have been adjusted to enhance the tax benefits of charitable giving. Here’s what you need to know:
The most recent change was incorporated within 2020’s CARES Act, which Congress passed to provide relief to those impacted by the global pandemic. In addition to providing paycheck protection for workers and support for small businesses as they struggled to survive the economic impact of coronavirus, the CARES Act also boosted the limit on cash donations from 60% to 100% in some situations. This increase is only valid for tax year 2020 and is limited to cash contributions given to charities that are not donor-advised funds or supporting organizations. Congress also is allowing a limited (up to $300) 2020 cash charitable contribution deduction for non-itemizers.
If you’re over 70.5 and you like to make charitable contributions directly from an IRA, you are able to donate up to a maximum of $100,000 per year via a Qualified IRA Charitable Contribution (QCD). This contribution will count towards your required minimum distribution, and because the distribution goes directly to the charity, it doesn’t increase your income and it still allows the donor to take advantage of the increased standard deduction.
Speaking of the increased standard deduction, when the 2017 Tax Cuts and Jobs Act (TCJA) boosted the standard deduction to $12,400 (for 2020) for individual taxpayers and twice that for married couples filing jointly, it cut the number of people taking itemized deductions, effectively removing an incentive for charitable giving. With only 13.7% of taxpayers estimated to have itemized their 2019 taxes, we have previously written about the benefit of “bunching”. Effectively, individuals can bunch their donations into a single year, thus allowing them to continue giving to the charities that they believe in while still taking an itemized deduction.
While the TCJA’s boost in standard deduction decreased the percentage of people itemizing, at the same time it boosted the deductibility of cash contributions being made from 50% to 60% of the donor’s adjusted gross income, making it more attractive for individual donors to give cash gifts.
Finally, in late 2019 Congress passed the SECURE ACT, which made a couple of notable changes, including pushing the age at which retirement plan participants need to take required minimum distributions (RMDs) from 70½ to 72, and taking away the ability for account holders to designate non-spousal beneficiaries who could hold onto them over the course of their entire lifetimes, taking distributions at will. Under the SECURE Act, those distributions need to be completed within 10 years’ time, making it a potentially better option to making the beneficiary a lifetime-income charitable vehicle in the form of either a remainder trust or a gift annuity funded with the account proceeds.
By indicating a beneficiary who will receive income over the course of their lifetime, you get the advantage of accomplishing the initial intent of giving to the beneficiary, and then upon the beneficiary’s death, whatever is left in either an IRA or a life insurance policy structured in this way gets distributed to the original benefactor’s designated charity.
Charitable contributions are an important part of our individual legacy. And when structured properly, they can also offer tax advantages. For more information on how you can leverage the new tax laws to benefit causes you care about as well as your own personal finances, contact Cray Kaiser today.
Please note that this blog is based on tax laws effective in December 2020, and may not contain later amendments. Please contact Cray Kaiser for most recent information.
With the year soon coming to an end, it’s time to think about year-end tax compliance, including W-2 reporting. While your outside payroll provider can report usual salary and wages without any issues, we often see errors in which employers don’t provide the W-2 preparer with taxable non-cash fringe benefits. Fringe benefits must be computed and included in employees’ wages prior to December 31 in order to allow for the timely withholding and depositing of payroll taxes.
Fringe benefits are forms of pay (other than money for the performance of services by employees) that are considered taxable income for that employee, unless specifically excluded by law. Certain taxable fringe benefits affect all employees while other taxable fringe benefits may only affect partners in a partnership or LLC, or more than two-percent shareholders in an S corporation.
The value of a company car used for personal travel must be included in the employee’s gross income as wages subject to FICA. This taxable fringe benefit applies to all employees with a company car. Be sure to request personal and total mileage from the individual so that the payroll provider can compute the taxable fringe benefit.
Most employees’ insurance coverage is a tax-free fringe benefit. However, health, dental, or vision insurance premiums paid on behalf of a partner or paid by the S Corporation on behalf of the two-percent shareholder is taxable for income tax purposes. These fringe benefits are only subject to federal income tax withholding (FITW) and state income tax withholding (SITW) and not FICA or FUTA. As insurance premiums may not be handled by the W-2 preparer, it’s up to the employer to ensure that this information is provided to the preparer for proper inclusion.
Employees are eligible to receive the first $50,000 of group life insurance coverage on a tax-free basis. Coverage in excess of $50,000 is taxable. For partners or two-percent S corporation shareholders the cost of all group-term life insurance coverage provided must be included in taxable wages.
The computation of the taxable benefit depends on the extent of coverage as well as the age of the insured. This fringe benefit is subject to FICA, however excluded from FITW, FUTA, and SITW. Please note that any life insurance coverage for which the corporation is both the owner and beneficiary does not meet the definition of group-term life insurance and therefore there is no income inclusion in the shareholder’s wages.
Unfortunately, year-end payroll reporting is not straightforward. There are different rules based on ownership status or the type of fringe benefits provided. Additionally, the computation of these taxable fringe benefits is the responsibility of the employer which is often why they become overlooked. If you have any questions or need assistance with your 2020 fringe benefits, please do not hesitate to contact us.
Please note that this blog is based on tax laws effective in November 2020, and may not contain later amendments. Please contact Cray Kaiser for most recent information.
Please note that this blog is based on laws effective in September 2020 and may not contain later amendments. Please contact Cray Kaiser for the most recent information.
The Internal Revenue Service (IRS) has resurrected a form that has not been used since the early 1980s, Form 1099-NEC (non-employee compensation). This form will be used to report non-employee compensation in place of Form 1099-MISC, which has been used since 1983 to report payments to contract workers and freelancers. Form 1099-MISC has also been used to report rents, royalties, crop insurance proceeds and several other types of income unrelated to independent contractors.
The revival of the 1099-NEC was mandated by Congress with the passage of the PATH Act back in 2015. However, there have been some complications with implementing the form, so its use has been delayed. It will now officially make its return in 2021 for payments made in 2020.
The reason for the change is to control fraudulent credit claims, primarily for the earned income tax credit (EITC), which is based on earned income from working. Scammers were filing tax returns before the normal February 28 due date for 1099-MISC, which does not give the IRS time to cross-check the earned income claimed in the returns. As a stopgap measure, 1099-MISC filings that included non-employee compensation were required to be filed by January 31, the same due date as W-2s, another source of earned income. By using the 1099-NEC for non-employee compensation, the IRS will be able to eliminate the problems created by having two filing dates for the 1099-MISC.
What will be included on Form 1099-NEC?
Luckily, the 1099-NEC is quite simple to use since it only deals with non-employee compensation (which is entered in Box 1). There are also entries for federal and state income tax withholding.
If you operate a business and engage the services of an individual other than one who meets the definition of an employee (i.e. an independent contractor), and you pay him or her $600 or more for the calendar year, you are required to issue the individual a Form 1099-NEC soon after the end of the year. This will help you avoid penalties and the prospect of losing the deduction for his or her labor and expenses in an audit.
The due date for filing Form 1099-NEC with the IRS AND mailing the recipient a copy of the 1099-NEC that reports 2020 payments is February 1, 2021. Please note that the due date is usually January 31, but because that date falls on a weekend in 2021, the due date becomes the next business day, February 1, 2021.
It is not uncommon to have a repairman out early in the year, pay him less than $600, then use his services again later in the year and have the total for the year exceed the $599 limit. As a result, you may have overlooked getting the information from the individual needed to file a 1099 for the year. Therefore, it is good practice to always have individuals who are not incorporated complete and sign an IRS Form W-9 the first time you engage them and before you pay them. Having a properly completed and signed Form W-9 for all independent contractors and service providers eliminates any oversights and protects you against IRS penalties and conflicts. If you have been negligent in the past about having W-9s completed, it would be a good idea to establish a procedure for collecting W-9s in the future.
As a reminder: IRS Form W-9 is provided by the government as a means for you to obtain the vendors’ data you’ll need to accurately file the 1099s. It also provides you with verification that you complied with the law in case a vendor gave you incorrect information. The W-9 is for your use only and is not submitted to the IRS.
The penalties for failure to file the required informational returns are $280 per informational return. The penalty is reduced to $50 if a correct but late information return is filed no later than 30 days after the required filing date of February 1, 2021. It may also be reduced to $110 for returns filed after 30 days but no later than August 1, 2021. And please note, if you are required to file 250 or more information returns, you must file them electronically.
Cray Kaiser can help you prepare your 1099s for submission to the IRS. If you’d like assistance, please contact us today at 630-953-4900. We’d be glad to help you!
Please note that this blog is based on laws effective in September 2020 and may not contain later amendments. Please contact Cray Kaiser for the most recent information.
During the COVID-19 pandemic, the Internal Revenue Service (IRS) furloughed many of its employees or had them work from home to mitigate the spread of the virus. Many IRS offices remained shuttered for months, thus a backlog of millions of pieces of unopened mail, including IRS checks, accumulated in trailers set up outside IRS facilities.
The unopened mail included payment checks, creating a problem for many electronically filed returns with tax due because the IRS computer shows a tax return filed but no payment made. Because the IRS utilizes a significant amount of automation, its computers began automatically generating tax-due notices to those who had mailed in payments. While most IRS facilities have reopened and IRS employees have returned to work, it will take them weeks, if not months, to get all of the backlogged mail opened and processed.
After receiving complaints from taxpayers and members of Congress, the IRS put information on its website about these outstanding payments. They stated that the payments will be posted as of the date when they were received by the IRS, not the date when they process them. In most cases, this will eliminate or minimize penalties and interest for late payments. So, if you mailed a check to the IRS that has yet to clear your bank, with or without a return, the IRS says that you should not cancel or put a stop-payment on the check. However, you should be sure that you have adequate funds in the account from which the check was written, so that the check will clear when the IRS does process it.
Normally, the penalty for a dishonored payment (a bounced check) of over $1,250 is 2% of the amount of the check, money order, or electronic payment. If the amount is $1,250 or less, the penalty is the amount of the check, money order, or electronic payment, or $25, whichever is lower.
To provide fair and equitable treatment during the COVID-19 emergency, the IRS is providing relief from bad-check penalties. The dishonored payment penalty will be waived for dishonored checks that the IRS received between March 1 and July 15 due to delays in processing. However, interest and other penalties may still apply.
The short answer: nothing. The IRS has decided to suspend mailing certain tax-due notices to taxpayers temporarily until the unopened mail backlog is cleared up. So, if you have received a tax-due notice but know that you already paid the tax, the IRS asks that you wait to contact it about any unprocessed paper payments that are still pending.
For now, it’s important to be patient. There’s no reason to send additional correspondence to the IRS as it would just be added to the mountains of unopened mail. And due to high call volumes, giving the IRS a call will be of little use at this time.
If you have any concerns about your uncashed IRS check, please contact Cray Kaiser.
Please note that this blog is based on laws effective in September 2020 and may not contain later amendments. Please contact Cray Kaiser for the most recent information.
All United States entities (including citizens and resident aliens as well as corporations, partnerships, and trusts) with financial interests in or authority over one or more foreign financial accounts (i.e. bank accounts and securities) need to report these relationships to the U.S. Treasury if the aggregate value of those accounts exceeds $10,000 at any time during the year. Failure to file the required forms can result in severe penalties.
The U.S. government wants this information for a couple of pretty obvious reasons. First, foreign financial institutions may not have the same reporting requirements as U.S.-based financial institutions. For example, they probably won’t issue the 1099 forms to report interest, dividends and sales of stock. By requiring those in the U.S. to divulge their foreign account holdings, the IRS can more easily cross-check to see if foreign income is being reported on the individual’s tax return.
The second and probably more significant reason is that the information in the report can be used to identify or trace funds used for illegal purposes or to identify unreported income maintained or generated overseas.
For 2019, the due date for filing this report was April 15, 2020, but the government grants an automatic extension to October 15, 2020 for those who didn’t file by April 15. This filing, the Report of Foreign Bank and Financial Accounts (FBAR), is not made with the IRS; rather, it involves completing Bank Secrecy Act forms and filing them electronically through the U.S. Treasury’s Financial Crimes Enforcement Network.
A penalty of up to $10,000 may be imposed for a non-willful failure to report; the penalty for a willful violation is the greater of $100,000 or 50% of the account’s balance at the time of the violation. Both the $10,000 and $100,000 amounts are subject to inflation adjustment, which, as of February 2020, brings them to $13,481 and $134,806, respectively. A willful violation is also subject to criminal prosecution, which can result in a fine of up to $250,000 and jail time of up to five years.
PLEASE NOTE: On Schedule B of the Form 1040 tax return, you must state whether you have a financial interest in or signature authority over one or more foreign financial accounts. If you answer yes but don’t file the FBAR, your failure to file may be considered willful, which could subject you to the larger fine and jail time.
The term “financial account” includes securities; brokerage, savings, checking, deposit and time deposit accounts; commodity futures and options; mutual funds and even nonmonetary assets (i.e. gold). Such an account is classified as “foreign” if the financial institution that holds it is located in a foreign country. Shares of a foreign stock or of a mutual fund that invests in foreign stocks are not considered foreign if they are held in an account at a U.S. financial institution or brokerage, so they do not need to be reported under the FBAR rules. In addition, an account maintained at a branch of a foreign bank is not considered a foreign financial account if the branch is physically located in the U.S.
You may have an FBAR requirement and not even realize it. For instance, say you have relatives in a foreign country who have put your name on their bank account in case of an emergency; if the value of that account exceeds $10,000 at any time during the year, you will need to file the FBAR. The same would be true if your name was added to several of your foreign relatives’ smaller-value accounts that add up to more than $10,000 at any time during the year. As another example, if you gamble at an online casino that is located in a foreign country and your account exceeds the $10,000 limit at any time during the year, you will need to file the FBAR.
You may also have to file IRS Form 8938, which is similar to the FBAR but applies to a wider range of foreign assets and has a higher dollar threshold. This form is filed with your income tax return. If you are married and filing jointly, you must file Form 8938 if the value of your foreign financial assets exceeds $100,000 at the end of the year or $150,000 at any time during the year. If you live abroad, these thresholds are $400,000 and $600,000, respectively. For other filing statuses, the thresholds are half of the amounts above. The penalty for failing to file Form 8938 is $10,000 per year; if the failure continues for more than 90 days after the IRS provides notice of your failure to file, the penalty can be as high $50,000.
As you can see, failure to comply with the foreign account reporting requirements can lead to severe consequences. Please contact Cray Kaiser if you have questions or need assistance meeting your foreign account reporting obligations.
Please note that this blog is based on laws effective in September 2020 and may not contain later amendments. Please contact Cray Kaiser for the most recent information.
Are you one of the many people in the United States who started working from home this year as a result of the coronavirus pandemic? You’re not alone. And while it is unclear how much longer the nation will be in the grips of this crisis, social distancing practices are likely to remain in place for most organizations. Some of the country’s most recognizable brands, including Facebook and Google, have already announced a work-from-home option that will extend through July 2021 for all of their employees, while others have made the ability to work remotely permanent.
As more and more organizations make the decision that their staff members can work from home either permanently or on a long-term basis, they may need to take a closer look at how nexus laws will be addressed — especially as several state governments are beginning to address work-from-home employees in terms of nexus and on tax revenue.
Traditionally, a state tax obligation is established when a business has a physical presence within its borders. That is what creates nexus. For example, if a Floridian goes to New York for a temporary job placement, they have an income tax obligation in New York for the money that they earn there. And if a Californian company places employees in Texas, then the company would have an obligation to follow Texas laws and pay Texas sales tax.
While New York Governor Andrew Cuomo explicitly continued making temporarily remote employees in New York liable for state income tax when COVID-19 struck, several states (including Massachusetts and Pennsylvania) made clear that the virus-related remote work would not trigger nexus obligations, at least as long as official work-from-home orders or states of emergency lasted. Today, as mandates are being lifted but companies continue to allow or enforce work from home, those states are beginning to reconsider their position.
While not every state has begun to address the tax ramifications of working-from-home due to COVID-19, Congress has. On July 27, 2020 new legislation was introduced with the goal of limiting the amount of state income tax that could be charged on income earned in state to residents of another state. The proposal revises Section 403 of the American Workers, Families and Employers Assistance Act (S. 4318), which says in part:
“No part of the wages or other remuneration earned by an employee who is a resident of a taxing jurisdiction and performs employment duties in more than one taxing jurisdiction shall be subject to income tax in any taxing jurisdiction other than: (A) The taxing jurisdiction of the employee’s residence (B) Any taxing jurisdiction within which the employee is present and performing employment duties for more than 30 days during the calendar year in which the wages or other remuneration is earned.”
The revision would extend the 30 days in part (B) to 90 days for calendar year 2020 “in the case of any employee who performs employment duties in any taxing jurisdiction other than the taxing jurisdiction of the employee’s residence during such year as a result of the COVID-19 public health emergency.”
Although this legislation has not been acted upon, we are hopeful that the federal government can provide overriding guidance on this issue. Without uniform guidance, each state is free to set their own nexus standards.
Nexus is a complicated topic. If you’re looking for additional information on nexus, click here. And as always, Cray Kaiser is here to answer your questions. Please contact us today to discuss how nexus impacts you and your business during the pandemic.
Please note that this blog is based on information known as of September 2020 and may not contain later amendments. Please contact Cray Kaiser for the most recent information.
As the November 2020 elections approach, you might want to know what the two front-running presidential candidates’ tax plans for the future are. The following is an overview of their positions, as we know and understand them today. However, the political and economic landscapes can and will change, and there is no assurance these plans won’t be revised or that they will have eventual Congressional backing. However, the information may be helpful as you look toward future tax planning.
Individual Tax Rates
Capital Gains Tax Rates
Basis Step Up on Inherited Property
Range from 10% to 37%. The top rate is scheduled to return to 39.6% in 2026.
Range from 0% to 20%; Collectibles top rate is 28%.
A beneficiary uses as their basis of an inherited asset the fair market value at the date of death. (Basis is the amount from which future gain or loss is determined.)
Generally, would continue with current rates by extending the Tax Cuts and Jobs Act past 2025. However, would lower the rate for middle class taxpayers, possibly by bringing the 22% rate down to 15%.
Would continue with current rates by extending the Tax Cuts and Jobs Act beyond 2025.
No proposed change.
Would return the top rate to the pre-tax reform 39.6% immediately (if approved by Congress).
Increase top rate to 39.6% for taxpayers with over $1 million of income.
Would eliminate the step up, either by taxing “paper gains” at death or assigning the decedent’s basis to the beneficiary (details not clear at this time).
Again, these plans are only proposals of what changes might happen based on the election results. It takes acts of Congress to move plans into law. With various scenarios in play, it might be wise to look at proactive tax planning to minimize future tax liability. Please feel free to contact Cray Kaiser to discuss your tax planning for next year.
Please note that this blog is based on laws effective in August 2020 and may not contain later amendments. Please contact Cray Kaiser for most recent information.
With jobs at a premium during the COVID-19 pandemic, you might consider hiring your children to help out in your business. Rather than helping to support your children with your after-tax dollars, you can instead hire them and pay them with tax-deductible dollars. Of course, the employment must be legitimate and the pay commensurate with the hours and the job worked.
If this is something you’re considering, we encourage you to read the following situations that are typically encountered when choosing to hire your child:
A reasonable salary paid to a child reduces the self-employment income and tax of the parents (business owners) by shifting income to the child. When a child under the age of 19 or a student under the age of 24 is claimed as a dependent of the parents, the child is generally subject to the kiddie tax rules, if their investment income is upward of $2,200. Under these rules, the child’s investment income is taxed at the same rate as the parent’s top marginal rate using a lower $1,100 standard deduction.
However, earned income (income from working) is taxed at the child’s marginal rate, and the earned income is reduced by the lesser of the earned income plus $350, or the regular standard deduction for the year, which is $12,400 for 2020. Assuming that a child has no other income, the child could be paid $12,400 and incur no federal income tax. If the child is paid more, the next $9,875 he or she earns is taxed at 10%.
Example: Let’s say you are in the 24% tax bracket and own an unincorporated business. You hire your child (who has no investment income) and pay the child $16,000 for the year. You reduce your income by $16,000, which saves you $3,840 of federal income tax (24% of $16,000), and your child has taxable income of $3,600, $16,000 less $12,400 standard deduction, on which the federal tax is $360 (10% of $3,600).
If the business is unincorporated and the wages are paid to a child under age 18, he or she will not be subject to FICA – Social Security and Hospital Insurance (HI, aka Medicare) – taxes since employment for FICA tax purposes doesn’t include services performed by a child under the age of 18 while employed in an unincorporated business owned by the parent. Thus, the child will not be required to pay the employee’s share of the FICA taxes, and the business won’t have to pay its half of these payroll taxes either. In addition, by paying the child and thus reducing the business’s net income, the parent’s self-employment tax payable on net self-employment income is also reduced.
Example: Continuing the same parameters as above, assume your business profits are $130,000, by paying your child $16,000, you not only reduce your self-employment income for income tax purposes, but you also reduce your self-employment tax (HI portion) by $429 (2.9% of $16,000 times the SE factor of 92.35%). And since your net profits for the year are less than the maximum SE income ($137,700 for 2020) that is subject to Social Security tax, then the savings would include the 12.4% Social Security portion in addition to the 2.9% HI portion. Thus, your total SE tax savings would be $2,261.
A similar but more liberal exemption applies for FUTA, which exempts from federal unemployment tax the earnings paid to a child under age 21 while employed by his or her parent. The FICA and FUTA exemptions also apply if a child is employed by a partnership consisting solely of his parents. However, the exemptions do not apply to businesses that are incorporated or a partnership that includes non-parent partners. Even so, there’s no extra cost to your business if you’re paying a child for work that you would pay someone else to do anyway.
Additional savings are possible if the child is paid more (or works part-time past the summer) and deposits the extra earnings into a traditional IRA. For 2020, the child can make a tax-deductible contribution of up to $6,000 to his or her own IRA. The business also may be able to provide the child with retirement plan benefits, depending on the type of plan it uses and its terms, the child’s age, and the number of hours worked. By combining the standard deduction ($12,400) and the maximum deductible IRA contribution ($6,000) for 2020, a child could earn $18,400 of wages and pay no federal income tax.
Example: Referring back to the original example, the child’s federal tax to be saved by making a $6,000 traditional IRA contribution is only $360 (tax rate of 10% of $6,000 would be $600, but the savings is limited to the actual tax of $360). So, it might be appropriate to make a Roth IRA contribution instead, especially since the child has so many years before retirement and the future tax-free retirement benefits will far outweigh the current $360 savings.
The above only considers federal income tax savings. As every state has its own rules on tax rates and dependency exemptions, it’s important to speak with your tax advisor about potential state implications of the above federal tax planning.
If you have questions about the implications of hiring your children or other possible tax benefits, please contact Cray Kaiser.
Note: Wages paid to children and other relatives aren’t eligible for the Employee Retention Credit created by Congress in 2020 as part of the COVID-19 emergency relief measures for employers.
