The Example.
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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 $165,000, and after including his wife Kelsey's teaching salary. some interest income, deductions, and a few other items Gary pays about $34,000 in federal income tax and another $23,000 in Self Employment tax. That puts his tax bill at a grand total of $57,000 for the year.
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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 $25 an hour, and Chris works about 50 hours per month. That puts Chris's earnings at $1,250 per month, 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 bonding over guitars. The store will no longer have net earnings of $165,000, since the wages paid to Chris, of about $15,000, 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 $3,700 less in federal income tax and about $2,300 less in Self Employment tax.
That is $5,000 in savings!
15So what about Chris? Since he earns less than $15,000 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 other federal taxes. So Chris pays absolutely no tax at all on his earnings and Gary gets the full tax deduction.