Can I hire my kid and start a Roth IRA for him?

Question

I own an LLC, of which I am currently the sole member. It's my main source of income.

I am wondering if there is a reason why I could not do the following:

1. Hire my child as a part-time employee of the LLC, for an annual salary of $5500.
2. Start a Roth IRA for the kid and put the $5500 into it.
3. Deduct the $5500 as a payroll expense for my LLC, thereby reducing my amount of taxable income.

To me, this seems attractive because I'd lower my LLC's tax liability. Meanwhile, my kid would not have to pay any taxes on the $5500 because it is lower than the standard deduction. And by putting the money in a Roth IRA, he'd get an investment that would grow tax-free. It would essentially be like getting the pre-tax benefits of a traditional IRA with the post-tax benefits of a Roth.

The way I see it, I'd win, my kid would win and the IRS would lose, for once.

Is there any reason this wouldn't work? There is no minimum age or income for contributing to a Roth IRA. So as long as I could legally hire my kid, I don't see any obstacles.

Answer 1

Forget the Roth for one moment.

Having a $5500 deduction for your LLC would be great. Parents hire their kids all the time. To do real work at a reasonable wage. Do you have work that's appropriate for the child and would it pass the duck test*? If not, don't do it. (per a request via comment - A duck test - "Is the work real and substantial enough that the the wage you are paying is what you'd be willing to pay a neighbor's kid, or any other kid, to do?" This is what I had in mind)

If you answered yes to the above, the Roth is a great account for the kid's money.

Disclosure - when my daughter was 11 and earning money babysitting, I offered her a deal. Keep notes on your sitting money. Name, date, amount. At the end of the year, I will give you an equal amount, deposited to a Roth IRA. She is a freshman in college, and already has $25K in her retirement account.

On reflection, and prompted by a comment, there are a few more things to consider. While the annual Roth limit is $5500, the standard deduction (in 2018) for your child is $12,000. This offers a larger opportunity to deposit to a college savings account, effectively deducting another $6500 from your income and putting it aside for a good cause. If you use a 529 account, the growth will also be tax free. A winning combination. And the only warning, be sure the pay is justified. Above $12K, and the child would start to see a tax due.

Regarding payroll tax, mentioned by a member comment on question, from the Forbes article See The IRS's Incredibly Generous Tax Benefits For Hiring Your Own Child

You don’t have to pay payroll taxes for employing your kids if your business is a sole-proprietorship, a single-member LLC taxed as a disregarded entity, or an LLC taxed as a partnership and owned solely by you and your spouse.

*If it walks like a duck and quacks like a duck, it's likely a duck.

Answer 2

Your child will pay state and federal taxes on the $5500. You could setup a Simple plan and then only pay state. You don't have to pay payroll taxes but the earner still has to pay tax on their income.