Hiring & Paying Your Kids to Work for You: A Smart Tax Strategy
Are you a small business owner looking for ways to save on taxes while teaching your children valuable life skills and a strong work ethic? Hiring and paying your kids to work for your business could be a savvy financial move.
Maybe you want your kids to help in the office over their vacations, after school, or on weekends. But are there limitations? How do you set them up properly and remain compliant?
In this blog post, we'll explore the tax benefits of this strategy, how it works, and the essential steps to account for it properly for tax purposes.
Benefits of Hiring Your Kids
Tax Savings: One of the primary advantages of hiring your children is the potential to reduce your tax liability. That’s right—you could avoid paying Social Security, Medicare, and unemployment taxes on your kid’s wages if they’re under 18! Learn more about small business tax preparation with tips for staying organized and maximizing your return.
Teaching Financial Responsibility: Hiring your kids allows them to learn valuable money management skills. They can learn about budgeting, saving, and investing while earning their own income.
Building a Strong Work Ethic: Early exposure to the world of work instills a strong work ethic in your children. They'll develop responsibility, time management, and teamwork skills that will benefit them in the future.
When & How Can I Hire My Kids?
According to the IRS, the job for which you hire your child must be reasonable and necessary. Follow these guidelines to remain compliant:
Determine Eligibility: Kids of any age can work for a business owned entirely by their parents. However, some states have age and time restrictions. Ensure your children are old enough to work in your state legally. Check your local labor laws for specific requirements.
Create Job Descriptions: Define age-appropriate tasks your children can perform within your business, such as filing, data entry, or basic customer service. For example, don’t give your five-year-old marketing assignments. And no, housework and yard work don’t count, either! The tasks must be related to your business.
Establish Fair Wages: Pay your children a reasonable and fair wage based on their responsibilities. It should be consistent with what you would pay an unrelated employee for similar work. If you’re unsure, stay safe by paying them minimum wage.
Document Work Hours: Keep detailed records of your children's hours, just as you would for any other employee. Have them complete timesheets or use time-tracking software.
Complete IRS Form W-4 and I-9, Eligibility Verification: You must withhold income taxes for your kids regardless of age. These documents will show you hired your child legitimately in the case of an audit.
Use a Separate Bank Account: For transparency and ease of accounting, consider opening a separate bank account for your children's earnings. This helps maintain clear financial records.
What are the Tax Benefits?
Kids under 18 are not subject to federal income taxes for the first $13,850 they earn (as of the 2023 standard deduction). They are also not subject to Medicare, Social Security, or FUTA taxes if you operate a sole proprietorship (Schedule C) or a partnership (LLC taxed as a married couple). Check out our guide on entity structures.
However, if your child is 18 or older, and your business is a sole proprietorship or an LLC taxed as a partnership, their wages may be subject to Social Security and Medicare taxes. But you can still save on FUTA (unemployment) taxes if they are under 21.
And corporations, estates, and partnerships must withhold Social Security, Medicare, and unemployment taxes on their kids’ wages, no matter how old they are.
The only workaround for S-corporations and C-corporations is to set up a sole proprietor “management company.” In this case, you would pay a legitimate management fee to the management company from the S-corp, then pay your child from the sole proprietorship or single-member LLC.
Is My Child’s Pay a Tax Deduction?
Yes, your child’s wages are tax deductible as long as their responsibilities and pay are reasonable, according to the above guidelines.
Does My Child Need to File a Tax Return if I Hire Them?
If a child's earned income (wages from working) exceeds the 2023 standard deduction of $13,850, they must file a personal tax return.
And even if they remain under the threshold, filing could still benefit them as they could be eligible for a tax refund.
Can I Claim My Kid as a Dependent if They Work for Me?
Yes, you can still claim your child as a dependent on your tax return even if you hire them to work for your business, as long as they are financially reliant on you and meet the remaining requirements for claiming a dependent.
Do I Need to Issue My Child a W-2 or 1099?
You only need to issue W-2s to those you hire and classify as employees, whether related or not.
If your kid is over 18 and you want to hire them, bringing them on as an independent contractor is typically easiest. If you do so and pay them over $600, you must issue them a 1099-NEC. This means you do not withhold income taxes from their pay or pay Social Security and Medicare taxes on their wages. Just be sure they pay these as self-employment taxes.
You might choose to hire your kid as a W-2 and put them on the payroll if you want them to contribute to a Roth IRA. Even if they are a W-2, you still don’t have to withhold FICA, FUTA, or SUTA as long as they’re under 18.
Can I Set Up an Investment Account for My Kids AND Hire Them?
If you set up a custodial investment account for your kids under 18, but all the income was from stocks, interest, and dividends, that is considered unearned income. As of 2023, the first $1,250 of that income is not taxable, and the second $1,250 of that income is taxed at the child’s tax rate, but any amount over $2,500 is taxed at the parent’s rate. This means your tax return rate of 24% x the amount of the kid’s unearned income over $2,500 would give you the amount they may owe, if any.
Remember, if you decide to set this option and your kids have also earned income as W-2 employees of your business, this will be combined income.
Final Thoughts on Hiring Your Kids
Hiring and paying your children to work for your business can be a win-win scenario, offering tax benefits while teaching your children valuable life lessons.
However, it's crucial to follow legal and tax guidelines, maintain proper documentation, and seek professional advice to ensure compliance. Doing so can make this strategy work to your advantage and set your children on a path toward financial responsibility and a strong work ethic.
Do you need guidance as you consider bringing your kids into the family business? Let JLS Accounting help you account for their pay and taxes appropriately! Book an intro call to learn more about hiring your kids and other savvy tax strategies today.