Family Business Owner Saves $39K with Income Splitting Across Entities

The Problem

This client operated a property management company and a related cleaning services business through a single-member LLC, generating $1.4M in combined revenue and $520,000 in net Schedule C income. The entire amount was taxed on the client's personal return at the 35% federal marginal rate plus full self-employment tax. The client's spouse and two adult children (ages 22 and 24) all worked in the businesses in legitimate roles but were paid informally or not at all.

By not paying family members for their actual work, the client was concentrating all income in the highest bracket and missing opportunities for FICA savings, income shifting, and retirement plan contributions for family members. The two adult children were in the 12% bracket on their own returns, and the spouse had no W-2 income. Properly compensating family members would shift income from the 35% bracket to the 12% bracket — a 23-percentage-point difference in marginal tax rates.

AE Tax Strategy

1. S-Corp Formation and Family Employment Under IRC §162 and §3121

We formed an S-Corp for the property management company and employed all four family members at reasonable compensation: the client at $125,000 (managing director), the spouse at $52,000 (bookkeeper/operations), and each adult child at $38,000 (property inspector and cleaning supervisor). Total family payroll: $253,000. The $128,000 paid to the spouse and children shifted income from the client's 35% bracket to their lower brackets (12% for the children, 22% for the spouse when combined with other income). The bracket differential on $128,000 produced approximately $19,200 in federal income tax savings.

2. Family Retirement Plan Stacking Under IRC §401(a)

With all family members on payroll, each became eligible for the company's 401(k) plan. The client contributed $23,500 (employee deferral) plus $31,250 employer match. Each adult child contributed $5,000 (employee deferral) plus $9,500 employer match. The spouse contributed $10,000 (employee deferral) plus $13,000 employer match. Total retirement contributions: $120,750, sheltered from current taxation. At the family's blended marginal rate, this produced approximately $14,800 in incremental tax savings above what the client would have achieved alone.

3. Accountable Plan and FICA Optimization

We implemented an accountable plan for the client's home office ($6,000/year), vehicle ($4,800/year), and technology expenses ($2,400/year). The S-Corp election removed $267,000 from the client's self-employment tax base, saving $15,400 in FICA taxes. After accounting for the FICA costs on family payroll ($19,400 in employer FICA on the $253,000 total payroll), the net FICA benefit was $5,000 annually. Combined with the income shifting and retirement plan benefits, total annual savings reached $39,000.

Before & After Comparison

Tax Category	Before	After	Savings
Income Bracket Shifting	$0	$19,200	$19,200
Retirement Plan Stacking	$0	$14,800	$14,800
Net FICA / Accountable Plan	$0	$5,000	$5,000
Total	$0	$39,000	$39,000

Key Takeaways

• Employing family members at reasonable compensation for legitimate work is one of the most effective and IRS-approved income shifting strategies available to family business owners.
• Adult children in the 12% bracket receiving income from a parent in the 35% bracket save 23 cents per dollar shifted — a dramatic and immediate tax reduction.
• Family 401(k) plans multiply retirement savings capacity by adding each family member's contribution limits to the total plan capacity.
• Children under 18 employed by a parent's sole proprietorship are exempt from FICA tax under IRC §3121(b)(3)(A) — but this exemption does not apply to corporate employers, so S-Corp structure must be considered carefully.