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The Other Child Tax Deduction – Part II July 23, 2008

Posted by federalist in Taxation.
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Part I of The Other Child Tax Deduction noted that each of your children can collect up to $850/year in “unearned” investment income without having to pay taxes on it or file a tax return.  This is worth several hundred dollars a year in tax savings.

If you have business income there is the potential for even bigger savings through your children: IRS Publication 501 notes that dependents do not have to pay taxes or file a tax return on earned income of less than $5,350.  (This is from the standard deduction, which applied to unearned income also, so if they’re collecting interest as suggested in Part I then they can only earn $4,500 in wages and still be exempt.)

A child can only collect wages or income that are reasonable for work actually performed, so one has to be careful with this.  But the exercise is worthwhile since payments to them not only avoid taxes but also reduce your gross taxable income.  Wages to children can be further exempt from FICA and FUTA if the business is entirely owned by their parents, which leads to even greater savings for the family.

Another bonus: A child with earned income is eligible to contribute to IRA’s (up to the lesser of their earned income or the annual IRA limit).  If you’re willing to file a W-2 this means they could collect $9,350 in wages, contribute $4,000 to a (deductible) traditional IRA, and not owe any taxes.

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