Assuming the same facts as in the previous example, Smith’s self-employment income would be reduced by $4,300. This would save her at least $125 (the 2.9 percent Medicare portion of the self-employment tax she would have paid on the $4,300 shifted to her son). If Smith were not over the Social Security wage base, shifting the earnings to her son could save her up to $533 (payroll and self-employment tax) more. All savings actually would be slightly less because Smith would get an income tax deduction for one-half of the extra FICA taxes if she paid them. Smith can also save some additional payroll taxes because earnings paid to a child under the age of 21 are exempt from federal unemployment tax. (Code Sec. 3306 (c) (5)). The FICA and FUTA exemptions are also available to a partnership consisting solely of parents. However, this exemption is not available to a C or S corporation.

The business can also provide the child with retirement benefits. If the parent-employer had a simplified employee pension plan, a SEP contribution can be made for the child, up to 15 percent of the child’s earnings. As long as the child’s adjusted gross income is below the level at which deductions for IRA contributions begin to be disallowed (for a single individual, the amount is $31,000), the child will not be disallowed his IRA deduction.

If the parent-employer has a SEP, contributions are mandatory for any employee, who has earnings over an annual-indexed figure, which is $400 for 1999. However, when you establish a SEP, you can set it up to exclude employees who have not attained the age of 21 as well as those who have not performed service during at least three of the immediately preceding five years.