Combining a Tax Strategy with a Wealth Building Strategy

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Combining a Tax Strategy with a Wealth Building Strategy


By Dance Romance, TSP Family Office |

Kids are expensive. There are costs that will be incurred year after year as the child grows. According to the U.S.Department of Agriculture, the average cost of raising a child to age 18 was $233,610 as of 2015. With an annual adjustment for inflation of 2.2% each year factored in, the lifetime cost of raising a child born in 2022 could be estimated at $272,049. With higher inflation, this amount is sure to be higher.

For most people, all the costs associated with raising the kids are paid for with after tax dollars. Mom and Dad earn their income, that income is taxed and reduced to a much smaller amount. After considering healthinsurance and 401K contributions, what’s left ove r to live on becomes even less. Business owners that have children are advised to put the kids on payroll as soon as possible. Rather than using after tax dollars that are left over, why not pay the kids with money before it’s ever taxed. By swapping dollars that have been federally taxed by up to 37% with dollars that will not be taxed, why not pay the kids with zero taxed dollars? This allows parents to gain some traction on their taxes and keep more money in their pockets.

Putting the kids on payroll creates an additional ordinary and necessary business expense. This payroll expense will decrease the amount of profit in the business, thereby reducing Mom and Dad’s personal income on the Form 1040 tax return and the taxes paid.

How much can you pay the kids? There are a couple of things to consider when determining how much the child should earn per year. The term “reasonable” is critical in two instances. First, the job that the child is doing must be reasonable based on their age and abilities. A four-year-old should not be operating equipment. Secondly, the amount that the child is paid must be reasonable based on the job he/she is being asked to do. You cannot pay a nine-year-old $20,000 a year to empty the trash three days a week simply because he/she is the owners child. The amount of pay needs to be an amount that an unrelated third party would be paid to do the same job.

The goal is to pay the child an amount up to the Standard Deduction. The Standard Deduction is a deduction awarded to a taxpayer if they do not have enough deductions to itemize. In 2022, the Standard Deduction for a single person is $12,950. This means that the child can earn $12,950, then take the Standard Deduction of $12,950. This results in taxable income of $0.00. There will be no federal taxes paid. There may be some state and FICA taken out of their check.

A custodial bank account should be set up for the kids. The money belongs to the child. It’s their money. Mom and Dad will have control over the funds. The funds can be spent on anything that is in the best interest of the child. Things like food, shelter and clothing are parents responsibility. When the child reaches age 18, they can have control of the bank account.

The simplest job description for kids is as a corporate model. There is nothing controversial about using the image or likeness of a child in marketing or advertising. Most company websites have an “About Us” page. This page will feature the owner of the business and a brief bio. To enhance this page, we recommend a family picture. The children can also be featured in social media postings. Baseball games, soccer games, dance recitals and vacation pictures make for a great way to show potential patients or clients that this business is a family-owned business. In general, most people seem to like doing business with a family-owned business.

With children under 14 years old we suggest using half of the Standard Deduction as a target for pay. Once the kids get older, they can do more and we can increase their pay. Children in their 20’s are earning over $20,000 as they can perform jobs such as social media coordinator. This job can be done even if the child is away at college.

Since the child has earned income, a Roth IRA can be set up in their name. The funds can be drafted out their custodial bank account. Maximizing a Roth IRA at $6,000 fits well within half of the Standard Deduction, $6,475. Once the child starts to earn the Standard Deduction amount of $12,950, there are more options for using these funds. For example, a 529 college plan can be funded. The younger the child is, the higher the growth opportunity on the investment. Let’s take a closer look. If a 5-year-old child is paid to be a corporate model and appears on his parents’ website, there will be annual earnings of $6,475. Then, $6,000 can be funded into a Roth IRA. If the contributions lasted for only 15 years and then stopped, with a modest 8.5% return, there would be a total of $189,792 in the account. That’s not a bad investment opportunity. We have time on our side. Let’s say that the $189,792 stays there for forty years, with no more contributions it continues to grow at 8.5%. At age 60, this “child” will have $4,959,838 in their Roth IRA account. Here’s the amazing part, these funds will not be taxed when the time comes to start taking the money out. This is how tax-free retirement is created. The chart below shows a simple view of this strategy in action.

In its purest form, payroll dollars are received in a tax-free environment and then placed into another tax- free investment environment. These funds are not even considered when Mom and Dad are doing their estate planning. This is the child’s money, in their name. No need to worry about gift tax or estate tax or any other tax. There will be no tax! This is how wealth is created. By using a simple tax strategy and combining it with a simple investment strategy.

To learn more, you can contact Dan Romance to schedule a one-on-one private call or Zoom meeting.

Dan Romance // Senior Sales Executive
TSP FAMILY OFFICE
2150 15th Avenue, Vero Beach, FL 32960
OFFICE 772-646-6906 // CELL 772-766-4637
dan.romance@tspfamilyoffice.com

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