With the changes made by tax reform, it is time to rethink the most profitable ways of taking money out of the family business.
Keep personal ownership of business assets (such as real estate and business equipment) and lease them to the company.
Benefits: You get to claim depreciation deductions for the assets on your personal return, giving tax-shelter benefits. Should a time come when the business no longer needs the assets, you may dispose of them for your personal account.
Hire family members who are in a low tax bracket (such as children or even parents).
Benefits: The business gets to deduct the payments at a relatively high tax rate, while the hired family members report income at a lower rate, thus cutting the family’s overall tax bill.
Family members may also become covered by tax favored benefit programs established by the business, such as medical plans and retirement programs.
Moreover, if you run the business as a proprietorship, you do not have to pay social security taxes on the wages paid to children under age 18. While tax reform limits the shifting of investment income to children under age 14, it does not restrict the shifting of earned income. In addition, the Tax Court has upheld salary deductions for children as young as seven years old.
Set up an irrevocable trust for a child over age 13 (or other low tax bracket family member), and give it ownership of assets used in the business (such as equipment or real estate). Then have the trust lease the assets to the company.
Lease payments made by the company will be deductible at its high tax rate while they will be taxed to the trust at a lower rate, again cutting the family’s overall tax bill. Important: The trust must have an independent trustee who will manage it in the child’s best interest.
Source: Tax Facts 1, 1999