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Employing Your Kids on Your Farm This Summer? Pay Them the Right Way
School's out for summer. That means a lot of farm kids are making the switch from the classroom to the family farm for the season.
If you've got teenagers working on your family's farm, you can get a lot more out of the experience than just knowing you're helping your son or daughter glean some valuable work experience and education; there are also some tax benefits to employing your children as long as they meet a few criteria and you structure the work agreement the right way.
As long as the young person's income is under $6,200 for the year and "unearned income," or investment income, is $350 or below, you don't have to withhold Social Security tax, says Iowa State University Farm Management specialist Charles Brown.
"If their investment income does exceed $350 and their total income exceeds $1,000, then they will have to pay income tax on their investment income," he says. "Unearned income (investment income) consists of such things as interest, dividends, and capital gains."
Brown uses the example of a parent giving a teenager an allowance of $5,000 for various chores and jobs around the farm during the summer. Doing this vs. paying a wage may be easier to manage, but you would lose out on some tax savings, Brown says.
"As an allowance, the parent is out $5,000 and has no tax deduction. Change this to an employer/employee relationship, and the $5,000 becomes a tax-deductible wage expense. The tax savings will vary, but for someone who is in the 15% federal tax bracket the tax savings (including federal, self-employment tax, and state tax) would be about $1,700," Brown says. "So the net effect is that your child’s labor really only costs you about $3,300. Again, the child would pay no income tax if this is the only income they have."
But, if you're going to take this route – paying a wage to garner the tax benefits instead of paying an allowance – be prepared to get the necessary paperwork in order to stay in compliance with tax laws.
"The child should receive a W2 at the end of the year as any other employee would. The child should also be paid a wage that is complimentary to the work being done. Paying the 5-year-old for doing fieldwork may not pass the scrutiny of the IRS," Brown adds. "Sole proprietors and husband-wife partnerships can pay their children, but corporations have no children, even though they may be children of the stockholders."
There's one more benefit to having your teenager making money for his or her summer farm work: savings opportunities.
"As an added benefit of the child now having earned income, a contribution could be made to a Roth IRA. The maximum IRA contribution for 2014 is $5,500, but it can’t exceed the earned income. The parent could make this contribution for the child, but the contribution would also count toward the $14,000 annual gift exclusion or $28,000 if both parents agree," Brown says. "Contributions to a Roth IRA are not deductible, but all withdrawals after age 59 1/2 are not taxable. Contributions of principal can be withdrawn at any time, and up to $10,000 of earnings can be pulled out when purchasing your first home. If the child was 15 years old when the $5,000 was invested, at 6% interest it would grow to about $80,000 by age 63 or $180,000 by age 75."