Family Payroll

April 13, 2006

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Another way of getting money out of your business at a minimum tax cost is to employ family members and put them on the payroll. This income-shifting technique requires that some justification be demonstrated. You can't just hand out paychecks to relatives who don't actually work for you.

For example, if your kids help in your business, you can pay them and they'll undoubtedly be in a lower tax bracket than you are. Then they can save their earnings to pay for college. But they must actually perform legitimate jobs for your firm, and jobs that they are qualified to do. If not, you run the risk of having their pay reclassified as "gifts" and taxed at a higher rate.

The most common way to utilize young children in your business is for them to provide cleaning services, or routine copying, filing and typing. These are jobs that even a 10-year-old is clearly capable of performing, and jobs that you'd arguably have to pay someone to do if your child were not available.

Putting your spouse on the payroll won't give you any tax savings if you file a joint return, but it will permit you to include the spouse in the retirement plan of the business, which would be a big tax benefit of a different sort.

If you do not have a C corporation, your health insurance premiums are not deductible to the business and are taxable to you. But premiums for employees, their spouses, and dependents are deductible, and if you employ your spouse, you'll be able to deduct the cost of your family coverage by virtue of your spouse's employee status. Keep in mind, however, this strategy won't work if your spouse is also a co-owner of the business.