Have you ever wanted to reduce the amount of tax you owe to the government? I certainly wish I didn’t have to pay any taxes, but the reality is that most of us are making enough money where we do have to pay taxes. Although the IRS will always try and get a piece of our income, there will always be ways to hide it from them. Today I want to share a few of the ways that those of us who have children, or will have children in the near future, can benefit from using our children to help lower our tax bills.
The first way our children can help us save taxes is by transferring investments into their name. The IRS allows children under 18 to have unearned income up to $950 without having to pay any taxes. The next $950 will only be taxed at the lowest tax rate, which is 10%. Anything over this threshold will be taxed at the parents’ rate, which can be 15% - 35%. Unearned income is usually from interest and dividends, but can be anything where you don’t actually “work” for the money. So the goal here is to transfer up to $1,900 into your child’s name. That can be as much as $570 in tax savings, and having your children report income (even at your higher rate) can produce other tax savings. Most of the tax credits and deductions that exist have income limits, so the lower we can get our income, the more credits/deductions we are eligible for.
A perfect example of this is from a family friend who has student loans. Up to $2,500 of student loan interest can be deducted from income if your modified adjusted gross income (MAGI) is below $70,000 ($145,000 married filing jointly). Their MAGI was $148,000 and they couldn’t take the deduction. If they had $3,000 transferred into their daughters’ name, they would have qualified for the deduction and ended up saving $39 in tax. And they might have even qualified for other deductions or credits to save even more money.
Another great way to save on taxes is to hire your children in the family business. Your goal here is to have wages paid to the children reduce the business’ income and therefore reduce the tax owed. This does of course have to be legitimate. You have to own a business and the child has to do actual work, so this probably wouldn’t work with a very young child (unless you own a modeling agency) but it is perfect for teenagers.
For the working parents among us, many employers offer reimbursement accounts for such things as child care and health savings. These accounts allow the employee to deposit parts of their paycheck tax free and then be reimbursed. What’s nice about these accounts is that your taxable income is lower and therefore less tax needs to be withheld from each paycheck. Here is how it works in relation to my family. My wife elects to have a daycare expense account through her employer and chooses to have the maximum withheld over the course of the year, which is $5,000. Each paycheck she receives will have approximately $192 taken out and placed in the account, tax free. When she submits her receipt for paying our daycare, she is reimbursed for that expense. The tax savings lies in the fact that at the end of the year she has $5,000 less in taxable income, which will save us about $1,250 in tax.
Reimbursement accounts are a great way to reduce your income tax if you are spending the money anyways. We already pay to have our kids in daycare and most kids, depending on their age, are seeing the doctor many times a year. These costs can all be paid into a reimbursement account. As mentioned above, a health spending account works exactly the same way, only the expenses are for health related goods and services (i.e. prescriptions, doctor visits, over the counter drugs, etc...). Since there are certain rules and restrictions it is important to talk to a tax professional to see how you can get the most savings come tax time.
Now, since the summer officially kicks off this Memorial Day weekend, I want to mention how we can deduct summer camp expense on our taxes. We already know we can deduct child care expenses, but did you know summer camps can be included? As long as your child is under the age of 13, attends a day camp, and the camp is to allow parents to work, then this expense can also be deducted as a child care expense. Paying for camp never seemed so fun!
There are other ways to reduce your tax liability through your children and these are just the most overlooked in my opinion. Taking a few minutes out of your day to set up one of these scenarios for yourself will save you a great deal over the years.
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