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Hire Your Child
Because the formula used for awarding financial aid require a far greater share of a student's assets than of parents, families should be very sure that they would not receive school based financial aid. If your family has determined that they will not receive school based financial assistance hiring your under-18 college-bound child is an option that can be used as a tax advantaged means of paying for college. In order for a family to take advantage of this strategy, they must operate a business as a sole proprietorship or husband-wife partnership. The concept is that the child will save and invest some of the wages for college. The wages are exempt from Social Security, Medicare and federal unemployment taxes, and your child can use the standard deduction to shelter up to $4,550 of 2001 income from income tax. Under these circumstances, your child will most likely owe zero federal tax or no more than 15% on some of his or her wages. It should also be noted that the kiddie tax is inapplicable on earned income.
The family business gets a business deduction for money that will be used to pay college expenses. Your income tax and self-employment tax bills are reduced and your adjusted gross income goes down as well.
Once your child reaches 18, you can continue employing her or him during summer vacation, school breaks and holidays. After age 18, Social Security and Medicare taxes will be applied, but your child's standard deduction still provides shelter from income tax. There's no federal unemployment tax before age 21.
If your business is not a sole proprietorship or husband-wife partnership, the child's wages will be subject to Social Security, Medicare and federal unemployment taxes, regardless of age. The standard deduction will however continue to create an income tax shelter for your child, and your business gets deductions for the wages and payroll taxes.
Your child could also use their earning to fund up to $2,000 in annual Roth IRA contributions. The contributions (not the earnings) can later be pulled out tax-free to help defray his or her college expenses. Please note that the earnings cannot be pulled out tax-free to help pay college bills. Additionally, the earnings provide a jump-started retirement account.
If your child is age 21 or older, no longer a dependent and still in college also an employee of your business and not an owner, you may be able to hand out up to $5,250 in annual education expense reimbursements. This employee fringe benefit is tax-free to your child, and you get a deduction on your business tax return. You should be warned that: (1) graduate courses don't qualify, and (2) if you have other employees you could would have to provide the same benefits for them as well. Consult with your tax adviser to take a careful close look at the rules under Section 127 of the Internal Revenue Code.
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