Win-win Situation The Benefits of Hiring Your Children In Your Practice

With today’s tough job market, finding employment for teens and college students can be a difficult task. Hiring your children to work in your medical or dental practice can not only provide gainful employment for them, it can also generate significant tax savings.

By employing their children, doctors can shift some of their highly taxed income into tax-free income or lower-taxable-income brackets.

As an example, if you employ your 16-year-old, he can earn up to $5,700 income-tax-free, and this is deductible to the practice. In a professional corporation with a federal tax rate of 35{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} and a state tax rate of 9.5{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5}, this results in a tax savings of $2,536. Furthermore, your child may be able to elect to have no income tax withheld by claiming a student exemption. That way, the child will not have to wait until after filing an income-tax return to get a refund of taxes withheld.

Even if you ultimately pay your child more than the standard deduction, you will still come out ahead in most cases since, after exceeding the standard deduction, your children will be taxed at a beginning federal rate of 10{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} versus the federal professional corporate rate of 35{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} or the individual federal rate of most health care providers (28{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} to 35{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5}).

If you own a professional corporation and pay your 16-year-old $11,000, the corporation realizes federal tax savings of $3,850. Your 16-year-old pays tax of only $530 ($11,000 – $5,700 = $5,300 x 10{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} = $530). This nets to a family savings of federal tax of $3,320.

Further savings are realized if you are a sole proprietor. If your employed children are under age 18, you will pay no Social Security or Medicare tax and, normally, no state unemployment taxes on their earnings. If you are incorporated or have a non-spousal partner in a partnership, you will have to pay payroll tax and withhold Social Security and Medicare, but the federal and state tax benefits still make it worthwhile.

Additionally, having earned income enables your children the opportunity to begin saving for their retirement through the use of a Roth IRA. Alternately, earnings can be placed in a traditional tax-deductible IRA, allowing the child to earn additional wages up to $10,700, all of which can be sheltered through the standard deduction and an IRA deduction. If you choose to fund a Roth IRA, this is still a great deal since the child will be taxed only at 10{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} or $500, and all future withdrawals including earnings will be tax-free.

When employing your children, it is important to keep adequate records as you would for any other employees. This may require having them punch a time clock or fill out time cards to substantiate hours and worked performed. Work must be bona fide, and wages must be reasonable based on the services performed.

Education credits can enable your child to earn an additional $2,500 tax-free, but certain rules apply. Most likely, you will not be able to utilize the American Opportunity Credit (previously called the Hope Credit) because your earnings subject you to the income-based phase-out rules. Your child, however, making $13,200 ($10,700 above plus $2,500), may be considered self-supporting and take advantage of the credit.

Although scheduled to expire after 2010, this credit may be extended. You should check with your CPA or tax advisor on the rules. v

Lisa A. Patenaude, CPA, is partner and co-director of the Health Care Services Division of Meyers Brothers Kalicka, P.C. in Holyoke; (413) 536-8510.