Ep. 97 | Maximize Your Tax Savings: How to Ethically Pay Your Kids Through Your Business

08/20/24 • 25 min

In Episode 97 of the Teaching Tax Flow podcast, hosts Chris and John delve into a powerful tax strategy, explaining how to income shift to family members or children. With the countdown to the 100th episode underway, this topic is timely and significant for business owners looking to control their tax liabilities. Chris and John unravel the intricacies of legally and ethically leveraging family members to optimize tax obligations, emphasizing that this strategy is not to be taken lightly or implemented illicitly.

Throughout the episode, Chris and John explore the benefits and implementation process of paying children for legitimate work in your business. By shifting income to lower tax brackets, parents can significantly reduce their overall tax burden. The discussion covers the importance of proper documentation, legitimate job roles, the advantages of different business structures, and the potential for utilizing earned income for additional benefits like Roth IRA contributions. Real-world examples make this episode a practical guide for those eager to harness this tax-saving strategy.

Key Takeaways:

Legitimate Employment: Children must perform bona fide work suitable for their age and capabilities to be paid.
Reasonable Compensation: Compensation must align with the nature of the work performed, avoiding any excessive payments that could raise red flags.
Proper Documentation: Maintain thorough records similar to those for any other employee, including timesheets, task records, and payroll tax filings.
Tax Benefits: Income shifted to children often incurs a lower tax rate or becomes tax-free, and specific conditions eliminate Social Security and Medicare taxes.
Roth IRA Contributions: Children’s earned income allows for contributions to a Roth IRA, promoting long-term, tax-free growth of their earnings.

Notable Quotes:

"The first benefit of paying kids is shifting the income to a lower marginal tax rate within the family." - Chris Picciurro
"If you want to be a duck, you got to walk like one and quack like one." - Chris Picciurro
"Ideas are cheap and implementation is valuable." - Chris Picciurro
"Highest and best use...identifying what you're good at and sticking to it." - John Tripolsky

Episode Sponsor
Sunsets & Dinks
www.teachingtaxflow.com/pickleball
CODE: TTF15

(00:04) - Income Shifting to Family Members for Tax Benefits
(06:40) - Benefits and Legalities of Income Shifting by Paying Children
(09:58) - Legal Tax Strategies Versus Risky Cheat Codes
(10:49) - Tax Benefits and Legalities of Paying Your Children
(19:21) - Tax-Free Growth Strategies for Teenagers
(21:45) - Legitimate Ways to Save Money by Employing Your Children

Key Takeaways:

Legitimate Employment: Children must perform bona fide work suitable for their age and capabilities to be paid.
Reasonable Compensation: Compensation must align with the nature of the work performed, avoiding any excessive payments that could raise red flags.
Proper Documentation: Maintain thorough records similar to those for any other employee, including timesheets, task records, and payroll tax filings.
Tax Benefits: Income shifted to children often incurs a lower tax rate or becomes tax-free, and specific conditions eliminate Social Security and Medicare taxes.
Roth IRA Contributions: Children’s earned income allows for contributions to a Roth IRA, promoting long-term, tax-free growth of their earnings.

Notable Quotes:

"The first benefit of paying kids is shifting the income to a lower marginal tax rate within the family." - Chris Picciurro
"If you want to be a duck, you got to walk like one and quack like one." - Chris Picciurro
"Ideas are cheap and implementation is valuable." - Chris Picciurro
"Highest and best use...identifying what you're good at and sticking to it." - John Tripolsky

Episode Sponsor
Sunsets & Dinks
www.teachingtaxflow.com/pickleball
CODE: TTF15

(00:04) - Income Shifting to Family Members for Tax Benefits
(06:40) - Benefits and Legalities of Income Shifting by Paying Children
(09:58) - Legal Tax Strategies Versus Risky Cheat Codes
(10:49) - Tax Benefits and Legalities of Paying Your Children
(19:21) - Tax-Free Growth Strategies for Teenagers
(21:45) - Legitimate Ways to Save Money by Employing Your Children

Previous Episode

Ep. 96 | Creative Ventures: Hobby vs. Business – Know the Difference

On this episode of the Teaching Tax Flow podcast, we jump into the intricacies of "Hobby Loss Rules." Aimed at demystifying the often confusing threshold between hobbies and businesses, the hosts break down how the IRS defines and treats these activities differently for tax purposes. The discussion is particularly timely given the changes brought about by the Tax Cuts and Jobs Act of 2017, which altered how hobby expenses are deducted.

Throughout the episode, Chris and John explain the nine-factor test the IRS uses to determine whether an activity is a hobby or a business. They illustrate these points with relatable examples, such as the potential tax implications of John's "passion" for knitting and dog breeding. The hosts also stress the importance of maintaining detailed records and having a clear profit motive to ensure an activity is classified as a business, thereby allowing for the deduction of legitimate expenses on your tax return.

Key Takeaways:

IRS Hobby vs. Business: Understand the IRS's nine-factor test to determine if an activity is a hobby or a business.
Tax Reporting: Recognize how to report income and expenses from hobby activities versus business activities.
Impact of Tax Cuts and Jobs Act: Learn how changes from the 2017 Tax Cuts and Jobs Act affected the deduction of hobby expenses.
Practical Examples: Real-world scenarios provided to illustrate what counts as a hobby and what qualifies as a business.
Next Steps: Practical advice on maintaining proper records and showing profit motives to ensure your activity is seen as a business.

Notable Quotes:

"The main issue is whether an activity is a hobby or business in the eyes of the IRS."
"Profit motive is crucial; hobbies typically have little effort to acquire the necessary expertise to consult a professional."
"For an expense to be deductible in your tax return for a business, the expense has to be ordinary and necessary."
"Under the Tax Cuts and Jobs Act of 2017, hobby expenses are no longer deductible, making it crucial to ensure your activity is classified correctly."
"The IRS provides a safe harbor guideline, known as the three out of five-year rule, which presumes profit motive if an activity generates profit in three out of five consecutive years."

Episode Sponsor:
The Mortgage Shop

(00:04) - Understanding Hobby Loss Rules to Minimize Lifetime Taxes
(02:58) - Hobby Versus Business: Tax Reporting and Rule Changes
(05:18) - Discussing Hobbies, Movies, and Financial Losses from Knitting
(07:13) - Determining If an Activity Is a Hobby or Business
(11:18) - Hobby vs. Business: The Gray Area of Tax Deductions
(12:27) - Determining Business vs. Hobby for Tax Purposes
(15:07) - Tax Implications of Hobby vs Business Income
(18:53) - Hobby Income Reporting and 1099K Changes
(19:55) - Business vs. Hobby: Tax Implications for Dog Breeding
(22:06) - Listener Appreciation and Engagement in the Defeating Taxes Podcast
(24:18) - Educational Investment and Tax Advice Disclaimer

Next Episode

Ep. 98 | Avoiding the Top 3 Tax Landmines That Could Cost You BIG $$

Welcome to Episode 98 of the Teaching Tax Flow podcast! In this episode, hosts Chris Picciurro and John Tripolsky delve into the often-overlooked pitfalls in tax planning, aptly referred to as the "Top Three Tax Landmines." They aim to educate real estate investors and other listeners on how to navigate the treacherous waters of tax obligations.

The discussion starts with Chris elaborating on depreciation recapture — the sudden surge in taxable income when you sell an asset you've previously claimed depreciation on. This intricate tax rule can catch you off guard if you are not prepared, especially in scenarios involving vehicles and real estate investments. Next, they explore phantom income, income that appears on your tax returns without actual cash realization. Often emerging from scenarios like cancellation of debt, partnership income, and barter transactions, phantom income can unexpectedly inflate your tax liability. Lastly, they examine the hazards of under-withholding taxes, particularly when experiencing significant life changes like job transitions or marital status modifications, which can cause a shortfall in tax payments.

Their conversation is enriched with tangible examples and actionable advice, highlighting the critical importance of tax planning. Chris and John delve into how a strategic approach to taxes can save you from unexpected financial burdens. For those looking to stay proactive with their taxes, this episode is a treasure trove of insights.

Key Takeaways:

Depreciation Recapture: When selling an asset for which you've claimed depreciation, you may need to include some of the previously deducted amounts as taxable income. This often surprises sellers who do not receive any cash but owe taxes on the gain.
Phantom Income: Income that appears on paper but does not provide actual cash, such as cancellation of debt, partnership income, or barter transactions, can lead to significant tax liabilities.
Under-Withholding Risks: Life changes such as job transitions, marital status changes, or adjustments in income can lead to under-withholding of taxes, resulting in an unexpected tax bill at year-end.
10% Penalty for Early Retirement Distributions: Taking early distributions from a retirement account before age 591⁄2 without qualifying for an exception can result in a 10% penalty in addition to regular tax liabilities.
401(k) Loan Pitfalls: If you leave your job, an outstanding 401(k) loan can become due immediately, creating taxable income and potentially subjecting you to a 10% penalty if not repaid promptly.

Notable Quotes:

"Tax flow does not equal cash flow." - Chris Picciurro
"Depreciation recapture can be a phantom income — no cash in your hands, but you owe tax." - Chris Picciurro
"Ignorance is not bliss when it comes to taxes. Ignorance is expensive." - John Tripolsky
"Just because taxes are withheld doesn't mean it's enough to pay what you owe." - Chris Picciurro
"With tax planning, you're not just preparing for the year-end. You're setting yourself up for a lifetime of tax efficiency." - John Tripolsky

Episode Sponsor:
REPStracker

www.repstracker.com/affiliate/teachingtaxflow (CODE: IFG)

(00:04) - Top Three Tax Landmines and How to Avoid Them
(07:25) - Depreciation Recapture Pitfalls in Vehicle and Real Estate Transactions
(12:32) - Tax Pitfalls, Atari Memories, and Italian Family Traditions
(14:39) - Understanding Phantom Income and Its Tax Implications
(19:53) - Tax Planning, Phantom Incomes, and Business Advice
(21:12) - Common Tax Landmines and How to Avoid Them
(27:29) - The Importance and Benefits of Tax Planning

Teaching Tax Flow: The Podcast - Ep. 97 | Maximize Your Tax Savings: How to Ethically Pay Your Kids Through Your Business

Transcript

Intro00:00:04.240

Welcome to the teaching tax flow podcast, where the goal is to empower and educate you to legally and ethically minimize taxes paid over your lifetime.

John Tripolsky00:00:16.274

Hey, everyone. Welcome back to the Teaching Taxable podcast, episode 97. The countdown continues to a 100. You can do the math. Pretty simple. So today, we are gonna look at a little bit of a smaller topic, a little bit of a younger topic, but