Income splitting is a legitimate and strategic tax planning approach used by high earners to lower their overall tax burden. In Texas, where there’s no state income tax, federal tax liability can still be substantial—especially for professionals and business owners. Income splitting allows high-income individuals to shift a portion of their income to family members in lower tax brackets, taking advantage of the progressive federal tax structure.

This article explores the most effective income splitting strategies for Texans, including methods for using family members in a business, distributing income tax-efficiently, and leveraging Texas’s community property laws. It also highlights legal considerations, limitations, and risks involved in applying these strategies.

What Is Income Splitting and How Does It Reduce Tax Liability?

Income splitting involves transferring taxable income from a high-earning individual to another person or entity taxed at a lower rate. Because U.S. federal income tax is progressive, each additional dollar earned is taxed at higher marginal rates. By legally shifting income to a lower-tax-bracket individual, such as a spouse or dependent child, a household can reduce its total tax liability.

For example, a business owner earning $300,000 annually might hire a teenage child to assist with administrative tasks in the family business. If the child earns $13,000 or less, that income is often taxed at 0% due to the standard deduction for dependents. That’s $13,000 no longer taxed at the parent’s marginal rate of 35%.

In Texas, income splitting strategies must still follow federal IRS guidelines, since there is no state income tax. These rules focus on substance over form, which means arrangements must have a valid business purpose and economic substance to be legally valid.

What Are the Legal Ways to Use Family Members in Your Business?

Hiring family members is one of the most straightforward and IRS-compliant ways to split income. If you operate a business or professional practice, employing your spouse or children can transfer income into their tax brackets while keeping money within the household.

Children under 18 employed by a parent’s sole proprietorship or single-member LLC are exempt from Social Security and Medicare taxes. Their wages are also fully deductible as a business expense, provided the work is real, age-appropriate, and properly documented.

Tasks for children can include:

• Office filing and organization
• Data entry
• Social media or website updates
• Model building or rendering prep (for architecture firms)
• Clerical work or client intake (for law offices)

Spouses can also be paid for legitimate roles in the business, such as:

• Operations management
• Marketing or administrative assistance
• Client relations or HR functions

It’s essential to pay a reasonable wage based on the duties performed, keep proper time logs, issue W-2s, and withhold applicable payroll taxes (except in the minor child exemption scenario). Payment must be made in cash, not just as book entries.

What Are the Most Tax-Efficient Ways to Distribute Income?

Business owners can reduce tax exposure by distributing income through pass-through entities such as S Corporations, partnerships, or LLCs. In an S Corp, income is split between reasonable salary (subject to payroll tax) and dividends (not subject to self-employment tax). This method alone can save thousands annually in Social Security and Medicare taxes.

For firms with multiple stakeholders, such as law or consulting practices, income can be allocated through Schedule K-1. This allows strategic assignment of income among partners or family-member shareholders, if ownership is legally structured to allow it.

Other income distribution methods include:

• Rental income: Leasing business property owned by a family member to the business creates passive income taxed at lower rates.
• Trust distributions: Irrevocable family trusts can be used to allocate investment income or business profits to beneficiaries in lower brackets.
• Gifting income-producing assets: While gifting income itself is prohibited, transferring income-generating property to a lower-bracket individual is permitted and may trigger gift tax considerations.

Each of these methods must be supported by written agreements, arm’s length pricing, and IRS-compliant documentation to stand up to audit scrutiny.

How Does Spousal Income Splitting Work in Texas?

Texas is one of nine community property states, which provides a unique advantage when implementing spousal income splitting strategies. In community property states, income earned by either spouse during the marriage is generally considered to be owned equally by both spouses, regardless of who earned it.

This means that even if only one spouse works, the IRS allows the income to be split evenly on a joint return, reducing the overall effective tax rate. For example, if one spouse earns $250,000 and the other has no income, the IRS will treat each as having earned $125,000. This can reduce exposure to higher tax brackets, the Net Investment Income Tax, and phaseouts for deductions or credits.

Spouses can also:

• Co-own businesses and split profits
• Be employed by each other under reasonable wage agreements
• Contribute to spousal IRAs, increasing retirement savings while lowering taxable income

Care should be taken to avoid triggering attribution rules, where income shifted between spouses is scrutinized due to lack of economic substance. All arrangements should be formal, with clear job roles and market-based compensation.

What Income Splitting Tips Apply to Professional Service Firms?

High-income professionals—including lawyers, doctors, architects, and consultants—face more restrictions when it comes to income splitting due to IRS limits on specified service trades or businesses (SSTBs). For firms over certain income thresholds ($191,950 single or $383,900 married filing jointly in 2025), the Qualified Business Income (QBI) deduction begins to phase out.

To work around this, professionals can:

• Elect S Corporation status to divide income into wages and distributions
• Hire family members for real administrative roles and deduct their wages
• Create multi-member entities with minority family ownership to allocate income through K-1s
• Establish pension plans like Solo 401(k)s or Defined Benefit Plans to defer income into tax-sheltered vehicles

For example, a medical professional in private practice can create an S Corp and pay their spouse $50,000 for real administrative work, while also contributing the maximum to their retirement plan. This shifts income into lower brackets and tax-deferred assets simultaneously.

It’s critical to observe the reasonable compensation standard, which requires that any wages paid—especially to family—be in line with market norms for the job description. Overpaying relatives may be reclassified as a disguised distribution and disallowed.

What Are the Risks and Limitations of Income Splitting?

While income splitting is legal, it’s tightly regulated by the IRS to prevent abuse. The IRS uses assignment of income doctrines, attribution rules, and economic substance tests to determine whether income shifting arrangements are valid or constitute tax evasion.

Common pitfalls include:

• Paying unreasonably high salaries to children or spouses
• Creating sham entities to distribute income with no legitimate business purpose
• Failing to document work performed or hours billed by family members
• Attempting to split income without transferring ownership or control

The IRS requires that arrangements reflect economic reality. Payments must be for real services, priced at fair market value, and supported by documentation such as employment agreements, payroll records, and bank transfers. Inconsistent recordkeeping or vague job descriptions can result in back taxes, penalties, or audits.

High earners using aggressive income splitting methods—especially those involving trusts or offshore arrangements—should consult experienced tax advisors and legal counsel to ensure compliance with IRS Code Section 482 and anti-avoidance statutes.

Final Thoughts

Income splitting offers high earners in Texas an effective, legal framework for reducing federal tax liability and managing long-term wealth. By leveraging family payroll strategies, community property laws, and tax-efficient entity structures, professionals can retain more of their income while staying compliant with IRS rules.

Hiring spouses or children must be handled with proper documentation, reasonable compensation, and real work assignments. Business owners should explore entity options like S Corporations or partnerships to enable strategic income distribution. Professional service providers must be especially cautious of QBI limitations, reasonable wage requirements, and attribution restrictions.

When done correctly, income splitting aligns with sound tax strategy, preserves wealth within the family, and minimizes audit risk. However, every scenario should be reviewed by a qualified CPA or tax attorney, especially as IRS enforcement efforts and audit scrutiny intensify for high-income filers.