Paint, Profits, and Progeny: A Guide to Tax Savings through Hiring Your Kids in Painting Businesses

Welcome to the Profitable Painter Podcast. The mission of this podcast is simple: to help you navigate the financial and tax aspects of starting, running, and scaling a professional painting business. From the brushes and ladders to the spreadsheets and balance sheets, we've got you covered. But before we dive in, a quick word of caution. While we strive to provide accurate and up-to-date financial and tax information, nothing you hear on this podcast should be considered as financial advice specifically for you or your business. We're here to share general knowledge and experiences, not to replace the tailored advice you get from a professional financial advisor or tax consultant. We strongly recommend you seeking individualized advice before making any significant financial decisions.

Hey, this is Daniel, the founder of Bookkeeping for Painters.

And this is Richard, tax director with Bookkeeping for Painters.

How's it going, Richard?

It's going really good, Daniel. How about yourself?

Doing well. Can't complain. I'm here, here in Cancún, Mexico, getting ready for our, our yearly employee meetup. Nice weather down here.

Awesome. Yeah, I'm certainly looking forward to it. Are you going to like scope out all the best restaurants and all the, the good activities before we get down there?

Everything's going to be heavily tested multiple times to make sure everything's safe and been fun before you guys get here. Yeah, for sure.

Sweet. Make sure that tequila works before, uh, yeah, you gotta test the tequila. Awesome, awesome. So we'll do the best we can to get through the podcast today. Um, no, we'll be fine. I'm, I'm really excited about this one. This is, uh, we're going to talk about a really cool tax strategy that has been kind of viral lately. I see this on Facebook and TikTok all the time. And it is a, it is a great tax strategy, but it does come with some caveats and you kind of need to know how to deploy it. And that is employing your children in your business.

Yeah, I figured as soon as they turn 7, you just get their painter whites on and get them to work, right? That's pretty much how you run it, right?

If they can hold a stuffy, they can hold a brush, right? Right. Yeah. Yeah. So you, you— yeah, 7 years old. I think that's the earliest that the child labor laws will kind of allow for children to work in your company. Of course, the job does need to be age appropriate. Probably don't want to have too many, too many second graders on scaffolding and on ladders. But there's definitely things that children as young as 7 can do for, for your business. But this is mainly like a tax strategy, right? The idea is that we want to shift money that we're earning and that's being taxed at a higher tax bracket over to somebody who has a lower tax bracket. As parents, we are always giving our kids money in one way or another. So we might as well figure out a way to do it where it is tax advantaged to us. So let's just kind of talk about the nuts and bolts of, of how this works. This all kind of comes down to the federal standard deduction. And if you filed your taxes before, you know that a certain amount of money is not taxed right off the bat. They call that the standard deduction. And in 2023, the amount for a single taxpayer is $13,850. So that is the amount that you can earn and you will pay zero federal income tax on that amount. So if you could take $13,000 of money that, that is normally going to be taxed at your tax bracket, that might be 24% or 32% or even higher. And shift that over to one of your kids and have it taxed at zero, you know, the benefit's pretty clear, right? So that's kind of the idea behind this, this strategy. Couple of things to be careful.

Oh, so I was going to say, like, if you, if you're shifting about $14,000 over and you're in, you know, your effective tax rate is somewhere around 24%, you're going to save, you know, $3,000 or so. So that's a good chunk of change for sure.

Yeah, absolutely. And the more, the more money you're making and the higher your tax bracket, the more you can save.

Mm-hmm.

But there are a few things that we want to, we want to kind of mention, a few things that kind of work against the, the tax savings here. And one is that federal income tax is not the only tax that we pay on money we earn. To make the strategy work, you do have to pay your children through payroll. It needs to be legit, right? So we can't just hand them a check, can't just hand them cash. We are employing them and we are paying them through payroll. And that means that their wages are subject to payroll taxes. That works out to be about— well, payroll tax is 15.3%, but payroll tax is also a tax deduction to your company. So just kind of a heuristic I use, I usually figure about 14% is what you'll end up paying, right? Yeah, 15.3% minus your tax deduction runs around 13-14% is what you're left with. So 13%, still less than your 22 or 24% tax bracket, still makes a lot of sense. That's, that's one aspect. The other aspect has to do with your state income taxes. If you are fortunate enough to live in a state that has no income tax like Florida, Texas, New Hampshire, Washington, there's a few others there. Then this is not an issue. You pay your payroll taxes and you're done. The rest is savings. But if you do live in a state with an income tax like, like I do, I live in Illinois, we have a 4.95% flat income tax. We need to take that into consideration because even though states tend to have either exemptions or deductions where a portion of your income is not taxable, it's usually not as generous as the federal $13,850. So like in Illinois, personal exemption is worth about $2,200. Anything above that, you're going to have to pay the 4.95% state tax. So now we're at 13% for payroll tax, 13, 14, throw on another 5% for state tax and that gets us up to, let's say, 19. We'll be a little pessimistic, say 19%. Well, 19% is still better than 24%. So there is still, you know, that, that room there, that arbitrage between the two. If you're in a 32% or a 35% bracket, that room grows much more. But now what if, what if you are maybe just starting out and you're in a lower tax bracket like a 10% or a 12% tax bracket? Now this doesn't really make sense, right? It doesn't, it doesn't make sense to trade 12% money for 19% money. And Daniel, do you have— Yeah, go ahead.

I was going to say, so just looking at the 2023 tax brackets, you know, the 12% tax bracket goes up to $90,000, about $90,000 for married filing jointly. So if you're making $90,000 or lower as married filing jointly, you know, you and the spouse, then that's most definitely doing the— this strategy wouldn't make sense. And then from $90,000 up, you get into the 22%. So that could start to— seems like it could start to make sense potentially because like you said, that 22% is is a, is a higher tax than you would have to pay even if you were in a, a state that you're paying a lot of taxes— income, income tax state, a high income tax state. Um, you know, it could start to make sense potentially over $90,000 when you're married filing jointly, uh, and then even more, more often probably at about $190,000 when you're in the 24% tax bracket. Could, you know, most, most of the time that probably would make sense. It sounds like.

Yeah. Yeah. You definitely want to be aware of what your tax bracket is. You and I discussed this strategy with my tax planning clients. The first thing we're doing is projecting your income and your taxes and knowing exactly what your tax bracket is and knowing whether or not it makes sense. But yeah, I think, I think that $90,000 is a good, good kind of like rule of thumb. And that's for married filing jointly. If you happen to be single, it's going to be about half that. So, you know, if you're making $90,000 and you're single and you, and you want to employ this strategy, you know, that might make even more sense. A couple, couple other things just to be careful of. This has to be legit. We do— we are employing our children, so we need to have them actually do some work in the company. Work can definitely and should be age appropriate. So no toddlers holding paintbrushes, unfortunately. Maybe finger paints, but not paintbrushes. So, so what are some things that are age appropriate? If you have a 10-year-old, could they help you stuff envelopes? Could they help you hand out flyers? Could they help you man your booth at a trade show? Those, those could be, you know, great jobs for someone who's 10 years old. If you have a teenager, do you need a social media manager? We've had several clients who have jumped on this idea. They say, my daughter's on social media all day anyway. She might as well be, you know, posting videos for my painting business, doing the blog posts or whatnot. And they really seem to respond well to it. The, you know, they're familiar with it and they enjoy it. and then they can get paid for it too. Um, so, you know, be creative, uh, but have some kind of age-appropriate work. And then you're also going to want to kind of keep track of their hours too. How many hours did they actually do this work so that you can run this through payroll and have, you know, all your i's dotted and t's crossed so that they're actually performing legitimate work.

Yeah, and this, I'm pretty sure from what I've read, this would be a definitely something an IRS auditor would look at if you do end up getting reviewed. If you're— if you have your family on payroll, they'll most likely ask for some sort of documentation, like you said, hours tracked. So make sure that that stuff is documented for sure. If you're doing this strategy, this is a little bit more aggressive strategy. When we do our tax planning with our clients, one of the things we always try to highlight is the risk that you're taking. And this is not to say nothing's illegal about it if you're doing it the way we're saying, but it is a more aggressive, aggressive strategy that you'll need to be prepared when a— when an audit comes up, you'll need to have hours and then be able to articulate what was the work that was done by your child, that kind of thing.

Yeah, absolutely. And to go along with that, I would say that the wage you pay needs to be appropriate. So, you know, $1,000 an hour is not an appropriate wage for a social media manager.

Come on. She's awesome at it though.

I know, I know. But, you know, the price on TikTok dances is just not what it used to be. No, but, you know, should they be well compensated? Yeah, absolutely. Especially if they're good at their job, but compensation that is within the realm of, you know, what could be expected, something that you can justify. So this— I'm at— I feel like I'm making this sound like more of a hassle than it's worth, but if this is done properly, there can be like really huge benefits. Uh, not only are you shifting high-tax money to a low tax bracket, you're also giving your child an opportunity to get started on their retirement savings. If that's something they want to do. Once they have earned income, they are eligible to contribute to a Roth 401(k) or a Roth IRA or your company's IRA. And so, you know, beforehand, Daniel and I were kind of running the numbers thinking like, well, just, just how valuable of a strategy can this be?

And before we get into that, just—

yeah.

For some folks that might not know the difference between a Roth and a traditional retirement, a Roth is the earnings grow tax-free, so there's no deduction for contributing to it, whereas a traditional one, you get the deduction in the year that you make the contribution, but then the earnings are taxed. The Roth is where the earnings grow tax-free, so there's no deduction up front, but the earnings grow tax-free, which in this case, the reason why we're saying Roth is because your, your child shouldn't be making more than the standard deduction of around $14,000 for 2023. So they don't need, they don't need a deduction, you know, because they already, they're getting that standard deduction. So they just need their earnings to be not taxed. So that's why we're recommending Roth.

Yeah, it's kind of like a backdoor way of almost double dipping, right? Because normally the earnings go into a Roth and they're taxed. In this case, they are taxed, but the tax rate is zero and then they grow and the growth comes out tax-free. So yeah, it's, it's a, it's kind of a neat plan. Maybe, maybe I can go ahead. Should I just go ahead and run the numbers and see what comes up? Okay, cool. So we talked earlier. Right now, the contribution limit on a Roth is $7,000 a year. So let's say of the $13,850 or whatever you're going to pay, $7,000 of that goes into a Roth IRA. And let's say just hypothetically, we start when your child is 12 and they work until they're 17. That's 5 years. So $7,000 times 5, $35,000. So over those 5 years, we're going to contribute $35,000 to a Roth IRA and we are going to leave this alone until retirement age. And the standard retirement age in the US right now is 67. So that is 50 years of growth. And when it comes to compounding interest in retirement accounts, time is more valuable than money. It is better to have a small amount of money grow over a longer period of time than a larger amount of money over a shorter period of time. So getting these contributions in when they're teenagers is kind of like a little bit of a window. And when that time is up, that window is closed, you know, you won't be able to get quite the same results. So $35,000, 50 years of growth, and let's assume a 10% annual rate of return. That is the average return on the U.S. stock market. So this would be, you know, typical something like index funds or mutual funds. Over 50 years. So what would that look like? Well, if you did that at 17 and left it alone until 67, your child would have $4.1 million tax-free that they could retire on, or they could leave it in there and continue to let it grow and send it off to the next generation. They would have lots of options. But that is how you turn, uh, a summer job, right, into a $4.1 million retirement.

Yeah, that's not too, not too bad. You could pitch it to your kid that way too, like, hey son, you want to make $4 million over the next 4 years? And like, yes. Like, okay, great, let's start, let's, uh, start your Roth. All you got to do is wait 50 years until you turn 67. They're going to love that idea.

Right, right. I know if I pitched that to my son, he would say, yeah, but my Pokémon game is available now.

All right.

So, but what's cool about that is like, let's say you did the full $13,000. Well, this is $7,000 and it's still $5,000 left over for, you know, having an awesome summer, for buying video games, for doing whatever you need to. You know, if my parents had set me up with something like this when I was a teenager, I would not have to worry about, you know, contributing to our retirement now. Hopefully I still would because, you know, but even if they don't do anything ever again, they're pretty well set. And yeah, $4.1 million will be worth a little bit less in 50 years than it is today, but it'll still be worth quite a bit.

Yeah, you could probably adjust, uh, we were talking about the annual rate of inflation, obviously it's gone up recently, but if we assume like a 3%, we could just reduce the 10% down to 7%, uh, compound interest, and then that would maybe have more of an inflation-adjusted return. And I'm sure it's still going to be at least a couple mil, or yeah, at least a couple million, I'd imagine.

It's about, it's about a, well, 7% rate of return grants you about $1 million after 50 years.

Yeah. Um, people retire off $1 million, so yeah.

And that, that's $1 million in today's money.

Yeah. In today's money. Exactly.

Yeah. So yeah. And, and this is just a, a start. It's certainly not, not the cap, but I think it's kind of a neat, neat way to kind of illustrate how powerful this strategy can be, you know, if done right and done aggressively. Not to mention, you are, you know, you're still saving, let's say, oh gosh, if you're in a 24% tax bracket in a tax-free state, you know, you're saving a good $1,300, $1,400 a year in taxes yourself. So, um, use some of that money to buy the, the Pokémon games if that's what it takes, right?

Uh, exactly. All right, um, so we talked about the overall concept: hire your kids, you know, when they're age appropriate, doing legit work, and just take into consideration your own tax bracket. You know, you want to If you're married filing jointly, probably need to be making more than $90,000. And then you also need to consider what state you're in. What does the income tax look like in that state? And then from there, you know, hire your, your kid or kids, put them to do legit work, uh, then make sure that they don't earn more than their standard deduction. Which in this year, 2023, is just right around $14,000. And then make sure you track their hours, make sure it's legit work, because if you get audited by the IRS, that's definitely going to be something they look at. So you're protected there. And from that, you should save a couple thousand dollars in taxes. And then a consideration, if you want to save even more and set your kid up for long-term success. So set them up a Roth-style retirement plan, Roth IRA or Roth 401k, whatever, and have them put all their earnings in that, and then they'll be a millionaire by the time they retire. And, uh, they'll, they'll love you for it, even though if they might not love you for it, you know, that at that point, maybe they would hopefully when they turn 67.

I'm sure they would. I'm sure they would. One other thing I just wanted to mention, you know, we're talking about employing your kids, your children. This is not limited to children. I have seen this strategy employed for maybe like elderly parents who need some help or who don't have any other income. I've seen this strategy employed for unmarried partners. Maybe you're supporting your partner and you're not married. You could have them work in your business, pay them up to that $13,850, and be able to save some money on taxes. So children's kind of the primary ones we look at, but it's not limited to just children.

Since—

all right, well, I think, I think that pretty much covers it. Is there anything else you wanted to add, Daniel, or No, I think, I think we got it covered.

Uh, so, and then we did a quick summary, so I think we're good to wrap this up. If you have any feedback on this episode, any thoughts on hiring your children and, and using this tax strategy, let us know in the Grow Your Painting Business Facebook group. Love to hear your thoughts on this. And, or if you have questions, if something wasn't clear, definitely let us know. Or give us some ideas on a future podcast.

Yeah, absolutely. We'd love to hear your opinions on this and if you think that this might work for your kids. So with that being said, uh, thank you very much for listening, and we hope to see you on the next podcast.