There are several strategies that a self-employed parent or parents can use not only to help pay for college but also save them money on their taxes. Let’s go through a few of them. Please note that this list is a sample and is not a complete list. Also, before implementing any of these you must consult your tax preparer.
One of my favorites is to hire and pay the child a wage. When you pay your child wages, they are considered a legitimate business expense, which means they are deductible from your business’s taxable income. This reduces your overall taxable income, thereby lowering your tax liability. It’s essential that the wages paid are reasonable for the work performed and are consistent with what you would pay any other employee for similar tasks.
If your child is under the age of 18 and you operate a sole proprietorship or a partnership where both partners are the child’s parents, you do not have to pay Social Security and Medicare taxes on their wages. This can result in significant savings on payroll taxes. However, if your business is incorporated, you will need to withhold and pay Social Security and Medicare taxes, just like you would for any other employee.
The money paid to your child can put into any investment you want. If done the right way that money grows tax-free and can be taken out tax free.
Let’s look at an example. Sara is a sole proprietor and pays her daughter, Laura, $14,600. Sara gets a tax break because that $14,600 is a business expense and as such is deductible on her tax return. So, if Sarah had income of $100,000, now her income would be $85,400($100,000-$14,600). At that income, her tax rate would be 22% so she would get a tax savings of $3,212 (22% X $14,600). This can be set aside to pay for college or whatever Sarah wants. Laura pays zero taxes. Why? Because the 2024 Standard Deduction is $14,600. The best part, all the money stays in the family, not the IRS.
Next, Sarah can invest that money for her daughter in several different vehicles to achieve tax-deferred or tax-free growth and tax-free distributions for college or even save it for retirement. I have my preferences as to college saving plans, you can e-mail me to discuss.
Want to Turbo-Charge this? Let's pay Laura $21,600. Again, Sara gets the tax deduction so now her income is $78,400 ($100,000- $21,600). Her tax savings is $4,752 (22% of $21,600) which she can put in the bank. So why does Laura pay no tax? The standard deduction is $14,600, Laura can then contribute $7,000, the 2024 contribution limit) to a traditional IRA and get the tax deduction. Note the family has savings of $26,532 ($21,600 +$4,752) that stays in the family.
This is what I call a Tax Scholarship!! Or Paying for College Tax Preferred!
You are going to pay for college anyway, you might as well make it Tax Preferred.
AS LONG AS YOUR KIDS ARE DOING LEGITIMATE WORK FOR YOUR BUSINESS, YOU CAN HIRE THEM TAX-FREE.
While hiring your kids certainly has its advantages, you must understand the specific IRS rules and regulations pertaining to this process.
When your child is doing legitimate work for your sole proprietorship or a partnership where each partner is a parent of the child, you do not have to pay Social Security or Medicare taxes if the child is under 18. However, the income should be reported, and they are subject to income tax if they make more than the standard deduction ($14,600 in 2024).
Remember, the work your child performs must be legitimate and age-appropriate. The wages should also be comparable to what you would pay another employee doing the same job.
There are countless age-appropriate jobs your kids can perform:
ü Cleaning the office
ü Washing company cars
ü Updating customer info
ü Data Entry
ü Social Media advisor
ü Transcribing video or audio
ü Trips to the post office or general errand running.
ü Helping out at the office
ü Handing out flyers
Lastly, ensure that you maintain proper documentation, just like you would for any other employee. This includes records of employment, timesheets, and payments.
Use Section 127 or 132 Benefits
If your child is working at your business, you may be able to take advantage of the Section 127 educational benefit. This rule allows the parent-employer to provide up to $5,250 annually in educational benefits to their child-employee. This benefit is tax-free to the employee and tax-deductible to the employer.
There are a couple of caveats, though. If you offer this benefit to your child as an employee, you must also offer it to other employees. And this benefit is available only if your child is at least 21 and is not a dependent of the business owner.
Meanwhile, Section 132 allows employers to provide (and deduct) other tax-free fringe benefits, including educational costs. Section 132 has its own restrictions, including requiring the educational expenses to be job-related. The education the employee receives also may not qualify the employee for a new trade; it must aid the employee in the position or career they are currently doing.
These deductions are available to businesses of all sizes and types, so do not feel you need a retail storefront to take advantage. If you have a side business like a sole proprietorship or an LLC, hiring your children to help your business during college may provide them with invaluable work experience while also helping them set aside funds for their college education
If you want more innovative ways to save and pay for college, click on the link and download my free-report "15 Strategies GUARANTEED To Reduce Your College Costs"