Meet Gary and his son Chris. Gary worked for GM for 22 years, but suddenly found himself "downsized" and unemployed. Instead of re-upping for another 22 years at Ford or Toyota, he chose to pursue a life-long dream of starting his own music store. Gary's shop specializes in high-end acoustic guitars like Taylor and Martin. Along with guitar sales they provide excellent service and in-store lessons. Last year the store had net income of about $65,000, and after including his wife Kelsey's teaching salary. some interest income, deductions, and a few other items Gary pays about $6,500 in federal income tax and another $12,000 in Self Employment tax. That puts his tax bill at a grand total of $18,500 for the year.
After visiting HireYourKid.com, Gary decided to hire Chris to help out in the store. Chris already shared Gary's passion for music and was at the store everyday after school anyway. Chris does some of everything...teaching, tuning, computer maintenance, and even taking out the trash when it's his turn. Gary now pays Chris $12 an hour, and Chris works about 10 hours a week. That puts Chris's earnings at $120 per week, which covers his movie nights and savings for that Taylor guitar at the store he has been eying. Gary points out that this is basically the same amount he was giving to Chris anyways. But more importantly Chris and Gary love being at the shop together. Chris's grades are up, his savings account is up, and he is showing signs of maturing out of teenage boyhood.
Now let's take a look at the tax impact of Gary and Chris's new bond over guitars. The store will no longer have net earnings of $65,000, since the wages paid to Chris, of about $6,000, are now fully deductible. Remember, this was money Gary had been giving to Chris for years now, but with no tax benefit as personal, non-deductible allowances. Since these wages reduce Gary's net earnings, Gary will now pay around $1,500 less in federal income tax and about $900 less in Self Employment tax.
That is $2,400 in savings!
So what about Chris? Since he earns less than $6,350 for the year, he is not even required to file a tax return. Also, since he is under the age of 18, there is no FICA, Medicare, FUTA, or any state taxes. So Chris pays absolutely no tax at all on his earning and Gary gets the full tax deduction.