From the dental and veterinary practice advisory newsletters, it sounds like the perfect solution. Your practice hires all your children say at age 12, and pays them enough in wages to fund a $5,000 ROTH IRA each year. When your child eventually retires at age 65, they have amassed $2,059,000, assuming (a) an equity risk premium of 6% and (b) that they continue to make the $5,000 contributions you had been making on their behalf until they reach age 65. I’m all for it, sort of.
Every well-intentioned plan is great in theory, and less successful in the absence of perfect execution. Very few of these newsletters outline in specific terms how to successfully navigate the seemingly simple, yet really complex, ways to stay within the law. Everybody wants to take advantage of “beating the IRS at its own game” or “implementing the 10 simple loopholes to save taxes the IRS doesn’t want you to know about”. And yes, there are positives in saving both income and payroll taxes for sole proprietors hiring family members, and tax savings for all practice owners who may hire family members. But in reality, when you cut aside the packaging and hoopla, the loopholes are pure marketing. And for sole proprietors that are more focused on hiring children rather than asking themselves why they are practicing as a sole proprietor, it sounds like the right time for an overall business strategy review.
In recent IRS audits, we have found that practice owners who couldn’t show evidence of actual attendance, job descriptions, and following established pay schedules of the non-family employees were the grounds for IRS agents disallowing the salaries paid to children. Even though counseled to do so from the first time the idea was presented to us. The practice owners very fortunate that the IRS didn’t disallow the ROTH IRA contributions and assess excise tax penalties.
How do you take advantage of paying your children, fund their ROTH IRAs, and stay within the parameters of IRS guidelines?
- When the IRS says that children should be hired for jobs that are commensurate with their age and skills, it doesn’t mean that a 2 year old should be hired to clean a fish tank or walk a dog. A 15 year old child may well be capable of updating a WordPress web page for the practice, but there should be reasonable job descriptions for each job, and you would apply it to any applicant, family member or not.
- Directly from the Massachusetts Attorney General’s Website: “Persons under 14-years-old may not work. There are a few exceptions to this, such as babysitting, working as news carriers, on farms, and in entertainment (with a special permit).” The AG’s website also makes a point of noting “The most protective laws are presented here and apply to all employers of teens in Massachusetts including family members who employ their teenaged relatives.” That means that there is no special exception for working at a family business no matter the enterprise, like a veterinary or dental practice. A work permit must be obtained from either the superintendent of the school system attended by the family member or the municipality where they work if the student is under age 18.
- We’ve seen children getting paid their entire calendar year wages on the last payroll of the year. We can’t say it enough. If you don’t pay your technicians or hygienists on December 31, don’t do the same for your children. They should be able to punch a time clock, log in to web-based time reporting systems, or fill out their hours as other employees. When your other employees open their paycheck or direct deposit stub, your children should be doing the same.
I always say it is never just one reason for success or failure. It’s a combination of events or circumstances. So is the hiring of a family member. It should actually be a celebrated occasion with much fanfare. It’s not just a job; it’s a passage to a grown-up world, or close to it. Assuming responsibility, getting a paycheck, being able to report on the next job application, and just being proud of your job. Those are all things I remember of my summer working as a 15 year old State Line Potato Chip bagging machine cleaner in high school. If I had a no-show job at my parent’s practice for a number of years to fund a ROTH IRA, this wouldn’t have been my first real job, and I wouldn’t have had so many eye-opening, but memorable, experiences.
Mark J. McGaunn, CPA/PFS, CFP® leads the veterinary/dental/financial planning divisions at McGaunn & Schwadron, CPA’s, LLC and can be reached via email@example.com or (781) 489-6651.