As we approach the fall harvest season, we thought it might be a good time to suggest one possible way for farming business owners to save on taxes while also investing in your family’s future – by paying your kids! As a family farm, many of you employ your children on the farm. Not only does it instill excellent work ethic and provide business knowledge, but if you employ your children you can save on taxes and help your children create wealth for later in their lives by using a custodial Roth Individual Retirement Account (IRA) on their behalf.
How could a Custodial Roth IRA Ensure My Next Generation is a Millionaire?
The S&P 500 has averaged an annualized growth of 10.13% since its inception in 1957 through 2023.
Scenario: If your child earns at least $7,000 annually in wages for work performed on your farming operation between the ages of 12 and 22, and all of those amounts are contributed to a Roth IRA account ($77,000 in total Roth IRA contributions over an 11 year period) – your child could have over $1,000,000 stocked away in a tax-free account for when the child turns 60.
In the above scenario, a Roth IRA account balance for your child at the age of 60 would be greater than $1,000,000 if the account experiences 6.50% in annualized growth. If the account grows 9.50% annually, the account would have close to $4,000,000. Approximate balances at different levels of growth rates over the almost 50 year time period are presented in this example:
Growth Account Ballance
6.50% $1,177,880
7.50% 1,771,545
8.50% 2,656,591
9.5% 3,972,240
How does an account grow to this large of a balance off of just $77,000 in contributions? Compound interest! The earlier you start, the longer you have until your retirement age to reap the benefits of your account growing exponentially due to interest more or less building upon itself over time.
So… what is a Roth IRA?
A Roth IRA is a retirement investment account that anyone with earned income can contribute after-tax earnings. Investments in a Roth IRA account grow tax free. A custodial Roth IRA is when a parent or other adult opens one for a minor. At age 18, the child becomes the owner of the account. It should be noted that Roth IRAs can have fees associated with them, so be sure you understand those before opening an account.
A Roth IRA is different than a traditional IRA. With traditional IRAs, you deduct contributions now and pay taxes on withdrawals later, while Roth IRAs allow you to pay taxes on contributions now and get tax-free withdrawals later.
What are the requirements of a Roth IRA?
A single filer with an adjusted gross income under $146,000 per year, regardless of age, is eligible to contribute to a Roth IRA account. Roth IRAs allow anyone with earned income, such as farming wages, to contribute after-tax dollars. People can contribute up to the annual limit ($7,000 for individuals under the age of 50 in 2024) or the total of their earned income, whichever is less. Contributions to a Roth IRA are not tax deductible. There is no need to worry about making annual contributions as there is no mandatory funding requirement for Roth IRAs. Note that income and contribution limits adjust annually and vary based on age, and marital status. You can look online at the IRS rules each year to see how the wage and contribution limits change as most years these numbers are adjusted due to inflation.
How is payroll to a child treated?
Your farming business gets a tax deduction for child wage expenses. The deduction reduces your federal income tax bill, your self-employment tax bill, and your state income tax bill, if applicable.
Additionally, your child’s wages when they are under the age of 18 may be exempt from social security taxes, medicare tax, and federal unemployment tax depending on the structure of your business. Your child can ultimately shield up to $14,600 of wages from any federal income taxes during 2024. It should be noted that there will be state income taxes due – but those are taxed at a much lower percentage.
One caveat to cover regarding hiring your child - your child’s wages must be reasonable for the work performed. You need to maintain the same records as you would for any other employee to substantiate the hours worked and duties performed. This includes timesheets, job descriptions and W-9 forms.
Savings vs. 529 vs. Roth IRA
There are other options for you to consider if you are employing your child and have monies you want to save on their behalf – should they simply put their wages into a savings account, a 529 education plan, or the Roth IRA account we have discussed so far?
A traditional place for families to put a child’s earnings is in a savings account. Savings accounts are likely to have a lower rate of return when compared to a 529 or Roth IRA.
A 529 account is a tax-advantage college savings plan. Similar to a Roth IRA, it is an investment account that is likely to earn a higher rate of return than a savings account. 529 accounts have no income limits or annual contribution limits, and anyone can contribute.
Many of you may look at employing your child to help save for their future college expenses. A Roth IRA account can now be used for qualified educational expenses.
Above is a table comparing and contrasting some key attributes of each type of account to help you make a decision.
Conclusion
Every situation is different and there is no one-size-fits-all solution. The scenarios and content of this article may not apply to you. However, if you find yourself in the situation where you are questioning if you should make a farm purchase to offset income and lower your tax payment, you may also want to consider the option of investing in your most valuable asset – your children!
Reach out to your local GreenStone tax and accounting professional to discuss options for your individual situation or if you need assistance with any financial related services. Our team of experts is ready to help!
To view the fall 2024 issue of Partners magazine in its entirety, click here.
