written by Melinda Thurman
A valuable strategy to maximize your practice value and reduce your taxes is family employment in your dental practice. Family employment allows you to shift higher-taxed income to lower-taxed income by utilizing family members and allocating some of the business earnings to your child. In addition, you can save on self-employment tax for sole proprietorships. This results in a financial gain for your practice and child.
Three Types of Tax Classifications
The family employment must be legitimate and reasonable compared to other dental office staff. There are different guidelines for family employment based on how the dental practice is classified for tax purposes. The 3 types of tax classifications include sole proprietorship, corporation and partnership.
Here is an example of a sole proprietorship practice with a dentist hiring his 16-year-old son. Assume the son works part-time, year-round and receives a reasonable compensation of $5,000, the potential savings are $1,750, assuming the practice earnings are taxed at 35%. If the total compensation paid to the son is less than the tax return standard deduction, he does not pay any taxes on this compensation received, thus benefiting the son by not being required to pay taxes. Even if the total compensation exceeded the standard deduction, the income could be taxed on a rate as low as 15% versus your tax rate of 35%.
The compensation paid to the child is also exempt from FICA and FUTA payroll taxes. The savings in employer FICA and FUTA payroll taxes could approximate $412 (based on compensation of $5,000). In addition, the child can receive benefits paid through the practice, i.e. IRA contributions, that could be tax-free. Keep in mind, for a C or S classified corporation, there is no exemption for employment of family members; therefore, they are subject to FICA and FUTA taxes.
The last type of tax classification is based on a partnership. With the partnership, the key determinate is who owns the business. For parents solely owning the practice and employing their child, the compensation paid is exempt from FICA and FUTA taxes. If the partnership owners are not the child’s parents or if there are additional partners, the compensation is subject to FICA and FUTA taxes.
It is important to understand the benefits of family member employment to determine effective ways to reduce your taxes and maximize your practice. To gain more knowledge on whether family employment is a great fit for your practice, contact us today.