The Small Business Owner’s Guide to College Funding

Are you a small business owner with a teenager bound for college? You should be taking advantage of a couple strategies that can reduce your college cost by thousands. What’s different about owning a business in the college planning process?  Income shifting and tax reduction, or the ability to reduce your personal income from the business by providing a benefit to your teenager, thus reducing your overall tax burden. Parents who are regular employees (W-2 employees) can’t use these strategies, but let’s show you how to leverage your business owner status.

Note #1: You shouldn’t stop your college money hunt with these business owner strategies. There are a number of other valid ways for you to reduce the cost of college, like focusing on college selection and a smart student loan approach.  This post is only meant to highlight a couple unique small business opportunities.

Note #2: I am not a CPA, and I am not your CPA! Tax strategies are complex and require a consultation with your business’s income tax preparer before proceeding with a plan. If you need help discussing this with your tax expert, please let me know.

Strategy #1: Employ Your Child

The time-honored tradition of having your kid work in your small business has a major upside for college funding.

Rules
To use this strategy, your teenager actually needs to do real work for your business. And, that work needs to be reasonably compensated. Whether s/he is cleaning the office, filing paperwork, or helping with actual customers, pay them a wage (by check!) comparable to a non-family member and keep records of time spent working.

Advantages
If your child is under 18, you don’t pay FICA or Medicare taxes on their wages. More importantly, it’s possible your child will have zero Federal and state income tax liability. Let’s look at an example for a married couple in Iowa:

You have $100,000 of taxable income from your small business this year. That puts you at 22% Federal and 9% Iowa marginal rates. Let’s say you have $10,000 in work that your 17-year-old could perform for the business.

• If you do that work and pay tax on it, you’ll owe $3,100 in income tax this year ($10,000 x 31%).
• If your child does the work, and because this amount falls under the standard deduction for income tax, they will pay $0 in tax on it!

Did you catch that? Your family, by employing your child, reduces the overall tax burden by $3,100 this year. Over the course of four years, that’s $12,400 in income that could be used to pay for the cost of college!

Things to consider
This is a strategy that works even if your child doesn’t pursue a four-year undergraduate degree. If your business offers some opportunities for your child to work, and they have an aptitude for learning your business, it can be a fantastic way to save taxes while in the prime college-funding years.

Strategy #2: Educational Assistance Programs (Section 127)

Educational Assistance Programs are designed for employers wanting to offer their employees a benefit that pays the cost of post-secondary education. In large companies, these are routinely used to fund MBAs and other graduate degrees, but they do count for undergraduate degree work, too. The employer can fund $5,250 per year for the employee, and it counts as a reduction in wages for the employee (and a business expense for the employer). You can see the advantage– this eliminates the tax consequence for the employee and reduces taxable income for the business.

Rules
These are called “Section 127 Plans” and you’ll want to review the IRS documentation on these plans (https://www.irs.gov/pub/irs-pdf/p15b.pdf). Some key items to keep in mind: you need a written plan document, and this must be offered to ALL employees (you can’t favor your children). You can offer this type of program in your small business, but for your child to qualify:

• Your child needs to be 21 years old (this doesn’t work for younger children) and a real employee (receiving W-2 wages)
• They must not be a dependent (they need to provide half of their own college and living expenses, more on that in a second)

Advantages
You, as the parent and business owner, are going to pay money for this program—this is not a free lunch. How you save money is the difference between what you, with your parent hat on, would have to pay for college, compared to what you, with your business owner hat on, will pay.  For example:

• As a parent, if you pay for $5,250 of tuition at a college, you will need to earn $7,608 in business income, if it’s taxed at the combined 31% Federal and Iowa taxes we used in the example above.
• As a business owner, if you pay for $5,250 of tuition at a college (really, reimburse your employee child), you will need to earn only $5,250 in business income. This payment is a business expense for you.
• That’s a difference of $2,358 in taxes you won’t have to pay each year as a parent! Since this strategy only works once your child is 21, you have maybe 2 years where you can use it. That’s $4,716 you’ll save on the cost of college!

Things to Consider
Very small business owners (even sole proprietors) can use this strategy, but if you own a larger business, you’ll want to think long and hard about offering this benefit, since all employees need to be offered the program. Fundamentally, if you have a college bill to pay for a 21-year-old or older child, this is a tax-savings strategy on money that you’re going to spend anyway.

If you own a small business and your child is college-bound, you have two solid strategies you can use to cut the cost of college. Make sure you do your due-diligence with your tax advisor and contact us if you’d like to discuss further ways to save on the cost of college!