Using Your Family’s Tax Brackets To Reduce Your Tax Burden

Effectively managing income taxes as a real estate investor shouldn’t leave you feeling overwhelmed. If you understand how the tax system works, you can find ways to reduce your tax burdens and liabilities. 

A basic feature of our tax system is its progressive nature, which places individuals into different tax brackets based on gross income. 

You can minimize your tax burden by hiring family members, and here I’m going to show you how. First, let’s review the applicable taxes that business owners should know about. 

Types of employment taxes for family members

Bear in mind that when you hire family members, they have to be treated the same way as other employees. The employment taxes that may be applicable to your family members can include:

• Federal Insurance Contributions Act (FICA) taxes are mandatory payroll taxes that fund Social Security and Medicare.
• Federal, State or applicable local income taxes also apply.
• Federal unemployment taxes (FUTA) or state unemployment taxes (SUTA) may be imposed on employers as well.

As we’ll see, when the family members hired to work for the business are children, you can be exempted from some taxes such as the FUTA and FICA. Sometimes, the income paid to minors may be totally tax-exempt.

How progressive tax brackets work

Generally, the federal income tax system is progressive. Tax rates are usually layered and sectioned into tax brackets such that the tax rate increases as income rises. Simply put, this means that you would fall in a higher tax rate bracket if you are a high earner, likewise, low-income earners pay at a lower rate. 

Here’s a (hypothetical) example of how progressive tax brackets can work:

• Less than $15,000: 7.5%
• Between $15,000 and $40,000: 15%
• Between $40,000 and $150,000: 20%
• Over $150,000: 30%

If a taxpayer’s income for the year is $100,000, he or she falls in the 20% tax bracket. However, the tax rates would be applied progressively—the first $15,000 will be taxed at 7.5%, the next $40,000 will be taxed at 15%, and the remaining $45,000 at 20%. 

Reduce your tax burden by hiring family members

Now, if you have children or grandchildren in lower tax brackets, there are legitimate ways to leverage their tax brackets to reduce your tax burden. The money you pay them will (because of their bracket) be taxed at the lower rate while bringing your own taxable income level down.

Using the family tax bracket strategy requires that you first identify where it would be appropriate for the family member to be employed. Document the responsibilities that the family member would take on. This does not have to be complex, especially if the family member is not an adult. The roles they fill could be anything from administrative to managerial; even “personal assistant” is fine so long as you document and define the duties.

Since you’ll be transferring income taxes to a child or relative with lower tax rates, there are things to consider:

• Hiring minors is fine if you make sure the work performed is allowable (and that the positions will qualify for tax deductions).
• After you hire a family member and put them on your business payroll, you need to ensure that the payroll expense is an ordinary expense that is related to the business operations. 
• Make sure the salary or hourly rate paid to the family member is commensurate to the job role. It needs to match the current market rate or you’re going to be asking for an audit. Ultimately, the payments made to a family member need to be justifiable.

You should use a payroll company. Don’t do the payroll yourself. As with other business processes and documentations, it is important to keep records for tax purposes. 

Your family member/employee will report the earnings on their tax return. If your family member is a minor, you’ll be filing a tax return on his or her behalf. Wages paid to a child are exempt from payroll taxes if your business is either taxed as a sole proprietorship or a partnership in which the only owners are the parents.

Here’s some more good news … You stand to save even more on taxes if your family member is not currently using their standard deduction!

Final thoughts

Hiring your family members to work for your business can indeed be a win-win situation if done right. This can provide an avenue to keep more income within the family and reduce tax liabilities for your real estate (or other) business ventures.

To learn more about this powerful tax savings strategy and others that you can use to keep more of your earnings, book a tax consultation by taking our tax quiz. The information you provide will enable us to have a productive discussion the first time that we speak.