Hire Your Children as Employees for your Business to Save Taxes

• You may be able to save considerable amount of cash in the form of tax savings by hiring your kids

• Your children may learn valuable business skills that they will keep for their lifetime

• The federal government, via tax preferential treatment encourages hiring children for your business

• The work and amount of pay must be reasonable in relation to each other, and in relation to the age and knowledge of the child.

• If improperly setup or executed, the business owner may face fines or lose some or all of the savings desired

• Your state may also have rules you must follow and may differ in tax treatment and other requirements

**Quick dis­claimer, while I am an attor­ney, I’m not your attor­ney or tax advi­sor with­out an express writ­ten agree­ment stat­ing oth­er­wise. You should NOT con­sid­er this legal or tax advice, and only as it is, name­ly edu­ca­tion­al mate­r­i­al that should be used as a start­ing point, not a deter­mi­na­tion of what is right or wrong for you and your busi­ness.**

Own­ing and oper­at­ing a small busi­ness can be an immense­ly reward­ing endeav­or finan­cial­ly and men­tal­ly, albeit it also comes with its fair share of chal­lenges, espe­cial­ly when it comes to tax lia­bil­i­ty. One often over­looked strat­e­gy for busi­ness own­ers that can pro­vide sig­nif­i­cant tax sav­ings is hir­ing your own chil­dren to work in the fam­i­ly busi­ness. Con­sid­er­ing tax­es can eas­i­ly eat up a large share of your prof­its, under­stand­ing how to min­i­mize your tax­es is vital­ly impor­tant.

While this approach requires care­ful adher­ence to var­i­ous rules and reg­u­la­tions, the poten­tial ben­e­fits make it well worth con­sid­er­ing. Some tax­pay­ers save thou­sands of dol­lars each year by chang­ing how they struc­ture their busi­ness oper­a­tions.

If your sit­u­a­tion allows for hir­ing your kid to help with your busi­ness, you may find the finan­cial and edu­ca­tion­al ben­e­fits out­weighs the rules, bur­dens, and require­ments that must be fol­lowed in order to do so.

Let’s start with the main advan­tage, and the one that gath­ers the most atten­tion, is that cur­rent­ly, for tax year 2024, a sin­gle tax­pay­er is gen­er­al­ly allowed a stan­dard deduc­tion of $14,600. This means, as an employ­ee (not sub­con­trac­tor which I will dis­cuss in fur­ther detail below), your child (actu­al­ly most any­one) can gen­er­al­ly get paid up to the stan­dard deduc­tion and not pay any income tax.

Fur­ther­more, the child or oth­er employ­ee earn­ing less than the stan­dard deduc­tion gen­er­al­ly does­n’t even need to file an income tax return (although some­times is advan­ta­geous for them to do so, which I will also explain below). The essence of how this works is sim­ple in con­cept and looks like this.…, the par­ent is able to deduct from their income the amount paid to the child, there­by reduc­ing their tax­able income, which is often (almost always actu­al­ly) much high­er than the child, and then pay the child who is not pay­ing any (or a much low­er tax rate if the income exceeds the stan­dard deduc­tion) fed­er­al and state income tax­es on the income the child earns work­ing for a parent(s).

As a quick exam­ple, for a par­ent that would oth­er­wise per­son­al­ly take the income and pay income tax­es at a mar­gin­al rate, this may result in a sav­ings of poten­tial­ly 37% from fed­er­al income tax (although, for most par­ents, the fed­er­al tax sav­ings is low­er, albeit sav­ings of at least 22% is very com­mon). For busi­ness­es that are locat­ed in states with an income tax, which is most of the states as well as most of the Amer­i­can pop­u­la­tion, the sav­ings is also increased by the amount of mar­gin­al tax reduced as well.

For exam­ple, a par­ent pay­ing a child $10,000 this year may save $2200 or more if the income is also sub­ject to state income tax.

The next key point and sav­ings that can be real­ized, is that for child employ­ees under the age of 18, nei­ther the par­ent nor the child is required to pay pay­roll tax­es com­pris­ing of Social Secu­ri­ty (FICA) and fed­er­al unem­ploy­ment (FUTA) tax­es, as long as the employ­ment is struc­tured prop­er­ly. It’s very impor­tant to struc­ture the strat­e­gy cor­rect­ly to avoid miss­ing out on this sav­ings. How impor­tant is this sav­ings, well, assum­ing a child under the age of 18 is paid $10,000 in 2024, the FICA and FUTA sav­ings is like­ly about $1500.

The actu­al sav­ings may vary depend­ing on sev­er­al fac­tors, includ­ing how much of the income would be sub­ject to FICA and FUTA if the par­ent sim­ply took the income, how­ev­er, for a sole-pro­pri­etor­ship, includ­ing a dis­re­gard­ed LLC enti­ty, it’s like­ly around $1500. Again, the sav­ings is not exact­ly $1500, albeit it’s a good ref­er­ence start­ing amount to use for deter­min­ing if it’s worth­while or not.

As you can quick­ly see, when a par­ent com­bines the income, Social Secu­ri­ty, and Fed­er­al Unem­ploy­ment tax sav­ings of hir­ing a child, the per­cent­age of income saved can be sub­stan­tial, and it’s a strong motive for a busi­ness own­er par­ent to deter­mine if hir­ing a child is worth pur­su­ing. And we’re only talk­ing about how much mon­ey is saved in tax, which is in addi­tion to the skills learned and busi­ness involve­ment for the child which is often over­looked and dis­count­ed in the begin­ning, albeit can turn into the biggest advan­tage over time.

More­over, many par­ents, includ­ing myself, gain great joy in work­ing with their kids. My one son who is past the eli­gi­bil­i­ty of this tax strat­e­gy works with me dai­ly and is one of the best things I cher­ish about being in busi­ness for myself.

Ok, you’re like­ly “sold” on the idea if you’re still read­ing, and now the next ques­tion that always comes up is “what’s the catch” and there are sev­er­al.

You must remain in compliance with the rules, which include:

Legitimate work:

Your kids must per­form bona fide, age-appro­pri­ate work that is nec­es­sary for the oper­a­tion of your busi­ness. Clean­ing their room, or per­form­ing house­hold duties is obvi­ous­ly like­ly NOT nec­es­sary for the oper­a­tion of your busi­ness. Hav­ing an eight year old per­form advanced book­keep­ing work is also not like­ly going to pass muster as well. Because there are so many dif­fer­ent types of busi­ness­es that have var­i­ous degrees of poten­tial work that can be per­formed by staff under 18, it’s impos­si­ble to list all the tasks they may be able to per­form for your busi­ness, I will high­light some com­mon tasks that if their age, intel­li­gence, and knowl­edge rea­son­ably sup­ports, may be con­sid­ered.

These include — cler­i­cal work, social media man­age­ment, and child mod­el­ing (ie pic­tures for your busi­ness web­site). For cler­i­cal work, maybe they deposit checks into your busi­ness using your phone app. Scan­ning and shred­ding doc­u­ments, data entry, plac­ing bills in envelopes and mail­ing, open­ing mail, clean­ing, vac­u­um­ing, and tak­ing out the garbage in the work office, back­ing up hard dri­ves and com­put­er data, tak­ing pic­tures for the busi­ness, and all sorts of tasks that maybe you as a par­ent would rather not have to do your­self, and you would oth­er­wise hire some­one to do any­way.

Reasonable Compensation:

You must pay your chil­dren a rea­son­able amount of com­pen­sa­tion for the actu­al work per­formed. Sur­pris­ing to some, this also means not pay­ing too lit­tle. You’re still required to pay the min­i­mum wage based on fed­er­al, state, and local reg­u­la­tions. You can run afoul of employ­ment law if you pay too lit­tle based on the amount of time worked.

More­over, you can not over­pay for the amount of time, skill, and work per­formed nei­ther. In oth­er words, you must pay a rea­son­able amount for the actu­al work per­formed, and gen­er­al­ly a good place to deter­mine the amount of pay is what would you pay anoth­er per­son of the same age and abil­i­ties who isn’t a rel­a­tive for the actu­al work. If you pay too much, you can expect the state and/or the IRS to push­back and deter­mine it was unrea­son­able, caus­ing you to roll-back some or all of the com­pen­sa­tion, and pay the tax­es as if you did­n’t pay your child.

Because these deter­mi­na­tions almost always hap­pen after the fact, the roll­back of income is like­ly to cause penal­ties and/or inter­est on the fail­ure to report and pay. In oth­er words, you can’t sim­ply make­up an amount based on what you want with­out first deter­min­ing what’s appro­pri­ate and expect to be “ok” from a tax lia­bil­i­ty point of view.

Documentation:

As with all busi­ness activ­i­ties, you want to gen­er­ate and main­tain prop­er appro­pri­ate doc­u­men­ta­tion as you would with any employ­ee regard­ing the duties, time sched­ule, and com­pen­sa­tion with the expec­ta­tion that it may be reviewed by the state and/or IRS. Hav­ing a full employ­ment con­tract with set expec­ta­tions and com­pen­sa­tion that are rea­son­able in light of all rel­a­tive fac­tors. Because the IRS tends to scru­ti­nize any, includ­ing child employ­ee busi­ness rela­tion­ships, involv­ing relat­ed par­ties, it’s essen­tial you have and keep prop­er doc­u­men­ta­tion gen­er­at­ed to sub­stan­ti­ate all busi­ness deal­ings with your child employee(s).

Compliance with Labor Laws:

As touched upon above, just because the employ­ee is your child, does­n’t mean you can ignore labor laws, includ­ing, and espe­cial­ly child labor laws. This includes the hours worked, how many hours, and any oth­er require­ments based on your state and local rules. While a 40 hour work week may be appro­pri­ate for a 17 year old dur­ing sum­mer break, it’s not like­ly per­mit­ted for a 12 year old dur­ing the school year.

Some states, includ­ing Wis­con­sin make no excep­tions for work­ers’ com­pen­sa­tion require­ments, while oth­ers allow relat­ed employ­ees to work with­out work­ers’ comp insur­ance. That being said, even if your state does­n’t require it, it still may be a good idea in case the work they’re per­form­ing could cause an injury. At a min­i­mum, it should be con­sid­ered even when the par­ent employ­ee is not required to have it in place. For states that require work­ers’ com­pen­sa­tion, you should bud­get about $300 a year, albeit it can vary wide­ly depend­ing on if they’re doing office relat­ed type of work, or outside/warehouse type of work.

If you’re still of the opin­ion this may be a good option to con­sid­er, here are some rea­sons why it may not make sense.

Increased Audit Risk:

As stat­ed already, you can antic­i­pate a greater like­li­hood of an audit. To be clear, gen­er­al­ly, the risk of audit should­n’t be a fac­tor because if any giv­en posi­tion by a com­pa­ny is well sub­stan­ti­at­ed through prop­er doc­u­men­ta­tion and is allowed under the laws and reg­u­la­tions, an audit is not a “big deal” most of the time. I advise clients to ALWAYS plan on an audit and con­duct their affairs assum­ing one will hap­pen. Most audits are per­formed via mail and requests for doc­u­men­ta­tion isn’t nec­es­sar­i­ly a seri­ous bur­den. How­ev­er, from a prag­mat­ic point of view, even when legit­i­mate and there is no risk of penal­ties, fines, or addi­tion­al costs, if there is very lit­tle tax sav­ings com­bined with addi­tion­al cost and work if audit­ed, some­times it makes sense to just pass on any giv­en strat­e­gy. That’s a ques­tion only the busi­ness own­er can make as peo­ple have dif­fer­ent views and opin­ions on what is worth­while and what isn’t. In order to help deter­mine if any giv­en strat­e­gy makes sense for you, it’s impor­tant to receive com­pe­tent and pro­fes­sion­al tax advice from some­one who can prop­er­ly guide you.

Complex Rules to follow:

Because hir­ing chil­dren is the excep­tion rather than the rule for hir­ing staff, the rules involved may seem com­plex and daunt­ing, espe­cial­ly for a new busi­ness own­er still try­ing to fig­ure out the rest of the busi­ness oper­a­tion. Again, this is a sit­u­a­tion where hav­ing prop­er guid­ance is key.

Financial Aid Impact:

Often col­leges and finan­cial aid is based on the amount of income earned and if your child employ­ee is earn­ing income, this may impact in ways that are not ini­tial­ly thought about, includ­ing poten­tial­ly finan­cial aid for col­lege.

Things to generally avoid:

Hir­ing your child as a 1099 sub­con­trac­tor. While doing so can make sense in some lim­it­ed cir­cum­stances, the strat­e­gy of hir­ing your kids as 1099s is some­thing I hear advised often from peo­ple who are not tax pro­fes­sion­als because they don’t under­stand that as a 1099, the child employ­ee may still be sub­ject to self-employ­ment tax. This is because the thresh­old lim­it for report­ing self-employ­ment income is much low­er than as an employ­ee. And a child employ­ee may lose one of the biggest ben­e­fits, name­ly not hav­ing to pay FICA tax.

Putting the income earned into a Roth IRA. I should first explain why some do this. The the­o­ry is that the child employ­ee can place mon­ey into a Roth IRA, have it grow tax free, and at some point in the future (ide­al­ly at retire­ment) take the earn­ings out tax free. This sounds great at the sur­face lev­el in the­o­ry, how­ev­er, for most, it fails to take account that the child can often if not like­ly, obtain a bet­ter result by sim­ply plac­ing the mon­ey into what is oth­er­wise an investment/bank that is sub­ject to income tax because for many, they’re not earn­ing enough to go beyond the stan­dard deduc­tion allowed.

This one admit­ted­ly “depends” on the sit­u­a­tion, how­ev­er, if the child isn’t earn­ing enough to pay tax­es on total income, includ­ing inter­est earned from sav­ings, it gen­er­al­ly does­n’t make sense to set­up a pay­roll and the oth­er costs asso­ci­at­ed with being able to make con­tri­bu­tions to a Roth IRA. Again, I must stress it’s a nuanced and fact spe­cif­ic sit­u­a­tion, how­ev­er, I see many cre­at­ing Roth IRA accounts for kids that real­ly see lit­tle if any actu­al ben­e­fit from doing so.

This is espe­cial­ly true for younger child employ­ees that could oth­er­wise earn tax free inter­est in a non-retire­ment account until they earn enough that it “mat­ters” and then at that point they could take their sav­ings and place it into a Roth IRA. For par­ent employ­ers with­out any oth­er employ­ees, and there­fore have to run a full pay­roll, along with the costs of a pay­roll, the costs great­ly out­weigh the ben­e­fits, if any at all, com­pared to hav­ing the funds placed into an invest­ment vehi­cle, includ­ing CDs and oth­er bank-relat­ed choic­es.

Creating or subscribing to a payroll service and/or software.

Along the same lines as a Roth IRA, many, if not most, states don’t require any for­mal pay­roll. If you don’t have to run a pay­roll and the asso­ci­at­ed costs, the bet­ter option is to not do so. There are more than one way to deduct your expens­es from your busi­ness that often does­n’t include an actu­al pay­roll pro­cess­ing to pay your chil­dren. This is again high­ly nuanced and requires a pro­fes­sion­al to eval­u­ate your spe­cif­ic sit­u­a­tion to advise how to prop­er­ly set­up the deduc­tions as an expense if you’re not run­ning a pay­roll.

Hav­ing your child work direct­ly for your sep­a­rate enti­ty. One of the pri­ma­ry rules is that the child must be an employ­ee of a parent(s). If you hire your child direct­ly from your sep­a­rate enti­ty, you may or may not be able to take advan­tage of the tax sav­ings desired. This requires care­ful and exact con­sid­er­a­tion to know if the strat­e­gy will work or not. From the IRS point of view, a busi­ness that is a sole pro­pri­etor­ship or part­ner­ship (where each part­ner is a par­ent of the child) is per­mit­ted (all else being equal and allowed) to take advan­tage of this strat­e­gy.

Cor­po­ra­tions are not par­ents:

On the oth­er hand, a Part­ner­ship,  LLC or Cor­po­ra­tion that is not whol­ly owned by the par­ents may NOT take advan­tage of this and are sub­ject to FICA, and oth­er pay­roll tax­es, even if major­i­ty owned by the par­ents. This can be an issue if the par­ents also have oth­er rel­a­tives with par­tial own­er­ship, includ­ing if one or more of the chil­dren have an own­er­ship inter­est. For many busi­ness­es, espe­cial­ly the ones that have an inter­est in tax sav­ings, an S‑corp elec­tion is a prob­lem too, even if whol­ly owned by the par­ents.

One workaround is hir­ing your kids in a sole pro­pri­etor­ship, often called or described as a “man­age­ment com­pa­ny” owned by the par­ents. The S Corp enti­ty sub­con­tracts work to the man­age­ment com­pa­ny that is a sole proprietorship,which in turn hires the under 18 year old child. This two-step approach requires the par­ents to cre­ate a sole-pro­pri­etor­ship, which is an addi­tion­al form on their per­son­al tax­es.

The net result is gen­er­al­ly a rea­son­ably near zero income above expens­es ide­al­ly. The par­ents will often be sub­ject to some self-employ­ment tax. Addi­tion­al­ly, if work­ers’ comp or oth­er expens­es are incurred, it does cre­ate a require­ment to care­ful­ly plan so that some rea­son­able amount of income is real­ized, and any income will like­ly be sub­ject to full self-employ­ment tax unless a par­ent is already above the con­tri­bu­tion lim­it, which is adjust­ed each year with infla­tion. If you allow the man­age­ment com­pa­ny to real­ize loss­es, you run the risk of not being able to deduct expens­es. 

Fur­ther­more, addi­tion­al sug­ges­tions are encour­aged, includ­ing open­ing a sep­a­rate check­ing account (not required, albeit is ben­e­fi­cial in the case of an audit as it lim­its what is audit­ed), obtain­ing a free EIN num­ber for the sole pro­pri­etor­ship (again, not required, albeit it’s a means to pro­tect your social secu­ri­ty num­ber), and depend­ing on the juris­dic­tion, a pay­roll ser­vice if required. Doing so may pos­si­bly increase the cost of your tax prepa­ra­tion, although it should like­ly be min­i­mal as there’s not like­ly a lot of activ­i­ty.

The next step in deter­min­ing if it’s a good idea or not is to first deter­mine the max­i­mum sav­ings you may pos­si­bly real­ize. Deter­mine what, if any, tasks your chil­dren can per­form, how much they’ll earn if you hire them, the qual­i­ty of the work (I don’t need to tell par­ents that moti­vat­ing their kids to do qual­i­ty “busi­ness grade” work isn’t always easy), and the inter­est of the kids they are con­sid­er­ing hir­ing.

Once you deter­mine how much you can rea­son­ably pay them in a year, you will have an idea of if mov­ing for­ward makes sense or not. As a start­ing point, and it varies great­ly from juris­dic­tion to juris­dic­tion, I would sug­gest that if you can rea­son­ably pay at least $3000 a year, and there­by save at least $1000 in tax­es, it like­ly is worth explor­ing. On the oth­er hand, if you’re think­ing of pay­ing your child or chil­dren $1000 or less a year, maybe it’s not worth the time, effort, and addi­tion­al costs.

What about the dread­ed Kid­die Tax:

Yes, I’m not mak­ing that term up. There is a Kid­die Tax, and even the IRS describes it as the “kid­die tax” on their offi­cial web­site.

The pur­pose and design of the Kid­die Tax is to dis­cour­age the wealthy from avoid­ing tax­es by trans­fer­ring assets to their chil­dren. What’s impor­tant to under­stand though, this rule tax­es a child’s unearned income (like cap­i­tal gains dis­tri­b­u­tions, div­i­dends, inter­est income, etc) at the parent’s tax rate if it’s over the annu­al lim­it ($2,600 in 2024). This applies to chil­dren under the age of 18 or full-time stu­dents under the age of 24.

But the Kid­die Tax only applies to unearned income. Because the income earned by your chil­dren in a fam­i­ly busi­ness is con­sid­ered earned income, the Kid­die Tax does not apply to this income. So if you’re pay­ing your kids to do an actu­al, real job … you have no Kid­die Tax, at least not from employ­ing your chil­dren.

Logis­tics:

You must actu­al­ly pay your child employ­ee. This may sound painful­ly obvi­ous, albeit some par­ents have the idea that they “will keep and man­age the mon­ey,” which is a great way to run into trou­ble with the IRS. As an employ­er, even for your kid(s), you must pay them based on the employ­ment agree­ment, and actu­al­ly make deposits into an account in your child’s name. Tech­ni­cal­ly, you could maybe pay in cash, how­ev­er, cash does­n’t leave much of a paper­trail, not to the extent of actu­al checks or direct deposits, and you WANT a paper­trail

Some par­ents will then use the mon­ey in the account to pay for things the par­ents may have paid for before. For exam­ple, the fam­i­ly goes out to eat. Instead of obtain­ing one bill for the meal, get two bills and have the child employ­ee pay for their own meal using their deb­it card. Your child needs new shoes, again, instead of the par­ents using their after-tax income to pay for the shoes, have the shoes paid for by the child’s deb­it card. Tak­ing your kid to a bas­ket­ball tour­na­ment, have your child pay for the gas, hotel, and entry fees them­self instead of you using after tax dol­lars from your account. You like­ly get the pic­ture here, name­ly that you still do the things you’re already doing and pay­ing for, and the only change is HOW you’re pay­ing for them. Instead of pay­ing the “dumb” way, you become tax smart and save a lot of mon­ey in the process, all while know­ing if you do things cor­rect­ly, you are in full com­pli­ance with fed­er­al tax law.

Final thoughts and com­ments. Yes, that’s my son Michael “mow­ing” the lawn in my back­yard. No, he’s not being paid from my com­pa­ny for mow­ing the lawn, although if I did pay him, some of the expense based on the amount of office space in my home MAY be reim­bursable by my com­pa­ny as part of the expense. If I have clients com­ing to my home, it’s more jus­ti­fied, oth­er­wise, if it’s not a true office expense, the work isn’t deductible. How­ev­er, there’s no rea­son why he absolute­ly could­n’t get paid as tal­ent for the pic­ture if the intent was to use him as tal­ent to cre­ate an image for the arti­cle. If he was paid, it would still have to be rea­son­able, and giv­en the amount of images out there that could be used, it’s like­ly the amount of com­pen­sa­tion would be less than many would like to pay. Cer­tain­ly, at least in this sit­u­a­tion, $500 is exces­sive, and like­ly even $100 would be exces­sive.

My point here is that unless your child is a true pro­fes­sion­al, pay­ing $500 plus for a pho­to­shoot may seem desir­able from a busi­ness tax­a­tion point of view, you can’t use the tax ben­e­fit to jus­ti­fy the amount of com­pen­sa­tion. In my case here, it took less than a dozen or so shots to get the best I was going to get, and that took all of less than prob­a­bly 15–20 min­utes (I was­n’t keep­ing track because I did­n’t have a need to). Did I cre­ate an expense to my busi­ness, no I did­n’t. Could I have? Prob­a­bly, albeit with so many legit­i­mate means with­in the tax code to reduce the busi­ness tax bur­den, I’m not going to spend the time and effort to save a few nick­els, while also poten­tial­ly giv­ing the appear­ance of wrong­do­ing. I like most, enjoy sleep­ing at night and there­fore, I attempt to find a rea­son­able bal­ance.

As with all busi­ness deci­sions, it’s impor­tant that you can go into an audit sit­u­a­tion where you’re not los­ing a night’s sleep because you tried to get cute with your num­bers. This includes not allow­ing the rel­a­tive­ly low audit risk to play any role at all in your choic­es. Too often it becomes a slip­pery slope and once the can is open, what could have been an easy stress-free audit turns into mul­ti-year audits, with an ever-grow­ing amount of things that get exam­ined and scru­ti­nized, and you get the pic­ture hope­ful­ly that it’s sim­ply not worth it. This is espe­cial­ly true giv­en there are so many ways to reduce your tax­es that are allowed if you fol­low the rules that gen­er­al­ly will keep your rates low­er than oth­ers with­out the stress and poten­tial risk to rep­u­ta­tion. 

If you would like to explore hir­ing your chil­dren as a tax sav­ing strat­e­gy fur­ther, feel free to reach out, or dis­cuss the mat­ter with a tax pro­fes­sion­al.