Legally Mine strives for excellence in helping our clients and the general public understand the current tax situation in the United States. The following is one of the many strategies and tax concepts that we teach. Please feel free to contact us at 800-375-2453 or firstname.lastname@example.org for more information.
Income shifting is moving taxable money from one individual at a higher tax bracket to another individual at a lower tax bracket. The amount of income multiplied by the difference in tax brackets is the resulting amount of tax savings. (Example: John and Jane make $300,000 per year. Their tax bracket is 33%. They have two children in college, costing them $15,000 per year per child in after-tax dollars. Instead of giving that money to their children, they can shift it to them. Each child reflects $15,000 of income on his or her tax return (which usually would result in little or no actual tax liability). John and Jane then report $270,000 on their joint tax return. The resulting savings are roughly $9,900 ($30,000 x .33)), not taking into consideration self-employment tax.
There are two basic ways to shift income:
1) Earned income- Earned income results when someone is paid a wage. There are many ways to justify earned income (meaning the individual is paid through a 1099 or a W-2). A dental practice could pay the dentist’s children for use of their photos on his or her website. A doctor’s office could pay the doctor’s children for shredding the papers for the office. A child could do administrative work, provide tech support or website design, or do advertising (social media, blogging, etc.) for the professional office. The possibilities are almost endless, but the wage must be reasonable (no $100,000 salaries for shredding paper part time). Keep in mind that you can pay a dependant earned income of approximately $5,750 per year without that individual needing to file a tax return.
2) Unearned income- Unearned income is income distributed to people through their ownership interests in a company (such as a limited partnership interest in a family limited partnership) or other interest-producing investment or account. There are three main considerations when shifting income through this method:
A) Income- In order to shift income, the business entity (FLP or otherwise) has to have income after all expenses have been met. There are several ways to generate income: interest from investment accounts owned by the FLP, management or consulting fees paid to the FLP for managing accounts and investments, rental income from houses owned under an LLC, management fees paid to the management LLC, etc.
B) Age- This form of shifting income is limited for dependents or individuals under 18 years of age (meaning the amount is limited to $1,000 per year for these individuals). It is also limited for full time students under the age of 24. For individuals who fall into that category, their unearned income simply cannot exceed their earned income. Any unearned income above the amount of their earned income is taxed at the parents’ rate. For individuals 24 years of age and older, there are no restrictions, so long as they are not claimed as dependents.
C) Ownership percentage- Tax is attributed to an individual’s ownership percentage in the business entity. If the FLP has $100,000 per year of income and you want to shift $30,000 per year to a child as unearned income, the child has to have a 30% limited partner interest (or membership interest for an LLC) in the FLP. Keep in mind that transferring ownership percentages could be a taxable event if the value transferred (in the form of ownership percentages) exceeds $28,000 per individual per year ($14,000 from each parent). More value can be transferred if parents want to tap into their estate tax exemption amount early. Tapping into that amount requires filing a special gift tax return.
 See IRS Publication 501 Table 2 (2012).