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Profit From Your Children

Making maximum use of your dependents can help slash your taxes significantly. "Dependents" generally mean your kids, but many of these gambits also work with low-income parents you might be assisting financially -- even if they aren't your dependents. Here are a few to consider.

Put them to work.
If you're an unincorporated business owner, consider putting your kids on the payroll. This allows you a double-dip tax savings of both income and self-employment taxes. Your kids won't have to pay any Social Security/Medicare (FICA) taxes on their wages if they're under 18, and they won't be subject to Federal Unemployment (FUTA) taxes if they're under 21.

With the 2006 standard deduction at $5,150, you can pay that amount to your child with no income tax consequences. That amount jumps to $9,150 if the child fully invests in a deductible IRA. If you're in the 25% tax bracket, you can save as much as $3,600 in income and self-employment taxes, and your child won't have to pay the IRS a dime! Even if your business is incorporated -- in which case the kids are subject to FICA and FUTA taxes -- it's still a substantial tax savings.

Give appreciated property.
Even with the new, lower 15% tax rate on long-term capital gains, giving appreciated property (such as stock) to that college-bound student or your low-income parents can save tax dollars. It's likely that your child or parent will be able to sell the asset and pay the tax at a 5% or lower rate. Since you gifted the property to them, you'll have no income tax consequences whatsoever when they sell the property.

Don't claim the dependent.
Many taxpayers with college-age children are barred from taking the Hope Scholarship Credit and/or Lifetime Learning Credit because their income exceeds the allowable limits. The solution? Don't claim that child as a dependent. If you forgo taking the dependent exemption, your child is allowed to claim the credit on his or her return. It doesn't matter if you're still paying the education expenses, or even if the child is still a dependent. Keep in mind that this gambit works only when the child has taxable income -- yet another reason to hire your child in your business.

Have grandparents fund the Coverdell IRA.
Is your income too high to fund a Coverdell education IRA for your child? It's likely that your parents' income is low enough to allow them to make the contribution -- even if you gift them the money used to make it.

These are just a few of the many ways you can maximize your dependents and minimize your taxes. We've discussed other ways in previous articles; if you're interested, go back and take a look.

When he's not dealing with tax issues, Fool contributor Roy Lewis is a motivational speaker who lives in a trailer down by the river. He understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks he owns, as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though.


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