Yes, you read the title correctly…you can save taxes by employing your children to work on your Christmas tree farm!
You can also use this strategy to give your children substantial retirement savings, while lowering your Christmas tree farm taxes each year.
Sound too good to be true? It’s not! Continue reading to find out how you can implement this strategy at your farm.
Tax Savings Example
Jill and Gil are married and own a Christmas tree farm that has a net profit of $215,000 per year. They have three children, Bill, Phil, and Will, who are all between the ages of 7-17 (more on the importance of the children’s ages later).
Jill and Gil employ their three children to help with farm tasks, such as mowing, shearing, planting, and harvesting. The children are paid a reasonable wage for the area and each earn $12,550 (more on the importance of this number later) in 2021.
Since Jill and Gil file jointly and are in the 24% tax bracket, employing their children will save them approximately $9,036 in federal income taxes ($12,550 wages * 3 children * 24% tax rate).
Further, since Jill and Gil are the only owners of the LLC that owns their Christmas tree farm, the children’s wages are exempt from FICA employment taxes (i.e., Social Security and Medicare).
Also, all three children will pay no federal income tax on their $12,550 wages because the 2021 standard deduction of $12,550 will reduce their tax liability to zero.
Finally, each child can contribute up to $6,000 to a custodial IRA (Individual Retirement Account) because they have earned income.
If Jill and Gil employ their children each year they are between 7-17 and the children contributes $6,000 per year to a Roth IRA, each child will have over $4 million tax-free at age 65 (assuming an 8% rate of return), even if the children never save another penny for retirement after age 17!
Even if Jill and Gil couldn’t pay their children the maximum and only paid them $1,000 per year that was invested in the children’s Roth IRAs, the children would still have over $669,000 tax-free at age 65, just by working on the farm and putting $1,000 per year into a Roth IRA for 10 years.
Child Employment Specifics
First, employing children ages 7-17 works best for this strategy because the courts have not permitted employing a child under 7 years old and you must pay FICA tax once the child is 18 years or older.
Second, this strategy works best for Christmas tree farms owned as sole proprietorships, single-member LLCs, or husband-wife partnerships (or husband-wife LLCs) since these entities are exempt from paying FICA tax for children under 18.
However, even if a child is 18 or older, or the Christmas tree farm is owned through a corporation or non-spouse partnership, you may still employ your children. The tax savings won’t be as large because the entity and the child will have to pay FICA tax, which is an additional 15.3% of the child’s wages. However, the wages and FICA taxes will still be tax deductible to the owners and the child will still be able to contribute to a Roth IRA for tax-free retirement income.
What if You Can’t Afford to Pay Your Children?
Common responses to this strategy are “I can’t afford to pay my children” or “My children already work for free…why should I employ them?”
If a Christmas tree grower is not generating sufficient profit to pay his children, there is still a way to utilize this strategy. The children are employed and the children use their tax-free wages to pay expenses the parents are currently paying, such as tuition, clothing, extracurriculars, or even some household expenses.
Further, even if the children already work for free, a net benefit will result from employment. The Christmas tree grower parents will get a tax deduction, the children will receive tax-free wages, and the children will also be able to begin saving for retirement early through a custodial IRA. And all these benefits result from paying the children to do work they were likely already doing!
Must-Dos for Employing Children
If you want to save taxes by employing your children, there are a few things you must do:
1) Must Setup Payroll
If you employ your children, you must setup formal payroll. Simply writing them checks from the farm account or issuing them a 1099 will not suffice. The children should be paid with payroll checks issued regularly, such as biweekly or monthly. To deal with the additional paperwork, I recommend using a payroll company.
2) The Child Must Actually Work
The IRS requires a “bona fide employer-employee relationship” with actual performance of services for the business. This means you should treat your children like normal employees. For proper documentation, the children should complete a timesheet that lists the date, the hours they worked, and what tasks they performed. Payroll should be calculated based on the hours listed on the timesheet.
3) The Child Must Be Paid a Reasonable Wage
The child must be paid at least the minimum wage for your state. However, you’ll likely want to pay more than minimum wage if possible. The child should be paid similar to how you pay other employees or what other employees of similar capability would earn on the farm. You can’t pay them more just because they are your children.
4) Must Comply With All Federal and State Child Labor Laws
Children under certain ages are sometimes restricted on how many hours they can work or what types of tasks they can perform. Make sure you comply with the federal regulations for young workers, as well as any child labor laws for your state.
5) Must Keep Detailed Records
Documentation is key! If you’re audited, the IRS is likely to scrutinize this area because of the parent-child relationship. However, you are likely to withstand scrutiny, if you setup payroll correctly, have the child keep a time sheet, document the reasonable wage, follow all applicable laws, and complete all other required payroll paperwork.
Conclusion
Christmas tree growers can achieve substantial tax savings, as well starting their children’s retirement savings, by employing their children. This strategy works best for children between the ages of 7-17, but is still available to any Christmas tree grower with a child at least 7 years old.
This article is an informational overview of employing children. If you are thinking of implementing this strategy on your own farm, you should consult with a knowledgeable CPA or attorney to ensure you are following all applicable laws.
