By employing family members, especially children, owners of a business can save income and payroll taxes. Family income tax can be saved by shifting some of the business earnings to a child, in the form of wages, for service performed by the child in your business. The work must be legitimate and the compensation must be reasonable in order to get a proper business deduction.

As an example, assume that Ms. Joan Smith is an attorney that operates as a sole proprietor. This summer, she plans on organizing her office, files, etc. Smith, who is in the 36 percent marginal tax bracket, can save family taxes by hiring her 15-year-old son. If he works full-time and is paid $4,300 over the course of the summer, Smith will save $1,548 at no cost to her son, who will be able to use his $4,300 standard deduction to completely shelter his earnings.

One item to remember is that the kiddie tax causes an under-age-14 child’s investment income in excess of $1,400 to be taxed at the parent’s marginal rate. It has no impact on the child’s earned income, which can be sheltered by the child’s standard deduction.

If there is enough work to keep the child employed longer, Smith can save an additional $720 in taxes by paying her son an additional $2,000. The son can then shelter his additional amount from tax by making a tax-deductible contribution to his own IRA. Even if you cannot shelter all of the child’s earnings, you can still save family taxes by transferring income to the child’s lower tax bracket. The child will then be taxed at a rate of 15 percent.

In addition, the parent can save on self-employment taxes, which is based on the net income of Smith’s unincorporated business. She will further be aided by the fact that a parent running an unincorporated business can also save on payroll taxes. This is because earnings of a child under the age of 18, who is employed in a business owned by his/her parents, will not have his/her earnings subject to FICA taxes (Code Sec. 3121 (b) (3) (A)).