A Business Owners’ Guide to Tax-Smart College Planning

A Business Owners’ Guide to Tax-Smart College Planning

January 22, 2024

More than two-thirds of parents are concerned about how to pay for their child’s college education, and business owners are no exception.1 You may worry about being able to manage college expenses while also having concerns about your child taking out student loans they may not be able to repay.

Fortunately, business owners have a couple of advantages when funding college expenses. Here are a few ways small-business owners might save money while their children are in college.

Hire Your Children at Your Business

Employing your children may be a great way to shift income from your business in their direction while they are still in a low tax bracket. For the 2023 tax year, tax filers as single individuals (or married filing separately) do not have to pay any federal income taxes on the first $13,850 in income.2 A business owner who employs a person (including a family member) may deduct this payment for the employee as a business expense.

If your child is a diligent saver, they may be able to set aside the first $6,500 in income (the maximum annual contribution in 2023) in a Roth IRA.5 Not only may Roth contributions grow tax-free for decades, but they also do not count against your child’s expected family contribution (EFC) on the Free Application for Federal Student Aid (FAFSA).4

Use Section 127 or 132 Benefits

If your child is working at your business, you may be able to take advantage of the Section 127 educational benefit. This rule allows the parent-employer to provide up to $5,250 annually in educational benefits to their child-employee. This benefit is tax-free to the employee and tax-deductible to the employer.3

There are a couple of caveats, though. If you offer this benefit to your child as an employee, you must also offer it to other employees. And this benefit is available only if your child is at least 21 and is not a dependent of the business owner.

Meanwhile, Section 132 allows employers to provide (and deduct) other tax-free fringe benefits, including educational costs. Section 132 has its own restrictions, including requiring the educational expenses to be job-related. The education the employee receives also may not qualify the employee for a new trade; it must aid the employee in the position or career they are currently doing.

These deductions are available to businesses of all sizes and types, so do not feel you need a retail storefront to take advantage. If you have a side business like a sole proprietorship or an LLC, hiring your children to help your business during college may provide them with invaluable work experience while also helping them set aside funds for their college education.

 

 

Important Disclosures:

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

This article was prepared by WriterAccess.

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Footnotes

1 Survey Says Parents Are More Worried about Paying for College https://www.savingforcollege.com/article/survey-says-parents-are-more-worried-about-paying-for-college

2 Standard Deductions for 2022 and 2023 Tax Returns, and Extra Benefits for People Over 65
https://www.forbes.com/advisor/taxes/standard-deduction/

3 26 U.S. Code § 127 - Educational assistance programs
https://www.law.cornell.edu/uscode/text/26/127

4 How a Student’s IRA Is Counted for Financial Aid
https://www.kiplinger.com/article/college/t032-c001-s001-how-a-student-s-ira-is-counted-for-financial-aid.html

5 Roth IRA Contribution Limits for 2023 Are Better Than Ever
https://www.fool.com/retirement/2022/11/19/roth-ira-contribution-limits-for-2023-are-better-t/