Paying your kids from your business is a legal way to reduce taxes for your company while utilizing your child’s standard deduction The standard deduction is a specific dollar amount that the IRS allows as a default deduction for most U.S. taxpayers. to provide tax-free income to your child. This strategy allows you to take a business deduction, teach your kids the family business, and keep money in the family. All businesses can deduct fair wages paid to the owners’ children and thus save income tax.
Key Takeaways:
- Sole proprietorships (SPs) and single-member LLCs (SMLLCs) save Social Security and Medicare tax on wages to your minor child.
- Children can earn up to $14,600 in 2024 (standard deduction amount) without paying any taxes with the filing of the child’s tax return.
- A child’s earnings make them eligible to set up a traditional or Roth IRA that can be used for the purchase of a first home, qualified education fees, and other specific expenses allowed by the IRS.
Tax Benefits From Paying Your Child
Provides Your Child Tax-free Income
If your child was hired at the local gas station instead of your company, they could still be eligible to earn the amount of the standard deduction ($14,600 in 2024), without owing the IRS. However, it is unlikely that the local gas station would hire your 12-year-old due to child labor laws.
But, since the IRS does not dictate a minimum age for hiring your child, you could hire your 12-year-old for age-appropriate tasks, like sorting documents and keeping the office clean. Working for you would likely be the only way a child of that age would even have a job. As a result, hiring your child allows the child to earn income and not be subject to income tax up to the standard deduction amount.
To further illustrate this idea, let’s assume that you paid your child $14,000 in wages in 2024. Here are the income tax benefits:
- Your child is not subject to income tax on their tax return (since $14,000 in wages is less than the $14,600 standard deduction) The child would not pay taxes in this scenario—as long as this earned income is the only income on the child’s income tax return. Tax withholding on the child’s income would still be required by the business, to be refunded by the IRS when the child’s tax return is filed. .
- Your business deducts wages against income subject to the tax rate for the business (up to 37% for sole proprietorship/pass-through entities), and the child avoids paying tax of 10%–12% for 2024 since their income is shielded by the standard deduction.
While some characteristics of these benefits would still apply if an employee were hired from the outside, paying your kids from your business allows you to keep these benefits within your family.
Enables Your Business to Save on Self-employment Taxes
Wages paid to your child not only reduce income taxes but also reduce the 15.3% self-employment tax on your Schedule C return. While this is true for all wages paid, 50% of the self-employment tax savings is offset by the 7.65% FICA tax your business has to pay on the wages.
However, if the employee is your minor child, your business doesn’t have to pay FICA taxes on the wages. You get to keep your entire 15.3% self-employment tax savings.
Helps You Get Your Child’s Retirement Plan Started Early
Since your child’s salary counts as earned income, you can set up a custodial Roth IRA or traditional IRA • If a Roth IRA is set up, the tax is prepaid, so there is neither income tax nor a withdrawal penalty when funds are withdrawn for eligible expenses.”> • If a traditional IRA is set up, income tax may be assessed when funds are withdrawn—but no early withdrawal penalty applies for eligible expenses.
• If a Roth IRA is set up, the tax is prepaid, so there is neither income tax nor a withdrawal penalty when funds are withdrawn for eligible expenses. for your child if you hire them. The child can be any age and only needs earned income and a taxpayer identification number (TIN) or Social Security number (SSN) to qualify.
For 2024, the annual contribution cannot be more than the child’s earnings or $7,000 This amount is indexed annually for inflation. . Since the child’s income is being shielded by their standard deduction—or at least taxed at a very low rate—it will generally be best to contribute to a Roth rather than a traditional IRA.
Roth IRA distributions are tax-free for a variety of reasons other than just retirement, such as the purchase of a first home. See the IRS’s list of allowable distributions for information.
Paying Your Child From a Sole Proprietorship or Single-member LLC
If your child is under the age of 18 and you pay that child from your SP or SMLLC, then these rules apply:
- Wages are subject to income tax withholding, although the income tax will likely be refunded on the child’s tax return.
- Wages are not subject to Social Security or Medicare taxes. This means that neither the employer or employee portions of social security or Medicare taxes need to be withheld for the minor child.
- Wages are not subject to federal unemployment taxes (FUTA) taxes.
- Wages must be reported to the child on Form W-2.
If your child is 18 or over and you pay that child from your SP or SMLLC, these rules apply:
- Wages are subject to income tax withholding.
- Wages are subject to Social Security and Medicare taxes.
- Wages are only subject to FUTA if the child is 21 or over.
The rules above also apply to a partnership where each partner is a parent of the employed child. Paying your child from your sole proprietorship or partnership can result in savings on Social Security, Medicare, and FUTA tax—depending on the age of the child.
Paying Your Child From a Partnership or Multi-member LLC
If parents are members of partnerships that are not solely owned by both parents, the following income tax rules apply to children of any age:
- Wages are subject to income tax withholding.
- Wages are subject to Social Security and Medicare taxes.
- Wages are subject to FUTA taxes.
However, the business can still take a deduction for wages paid to the child.
You may set up a separate company that is a sole proprietorship or single-member LLC and create a working arrangement with that company to pay your child. Under those circumstances, the sole proprietorship rules would apply, which could reduce Social Security, Medicare, and FUTA taxes, depending on the age of the child.
Paying Your Child From an S or C Corporation
As with partnerships with non-parental partners, children of any age are subject to all of the standard taxes on income, as referenced below:
- Wages are subject to income tax withholding.
- Wages are subject to Social Security and Medicare taxes.
- Wages are only subject to FUTA taxes.
Salaries are an ordinary and necessary business expense—but a child’s wages may still be deducted. As with partnerships and multi-member LLCs (MMLLCs), a separate SP or SMLLC can be established as a payroll management company from which your child can be paid.
The chart below summarizes the applicable taxes by entity type.
Note that if the child does not earn income over the standard deduction amount ($14,600 for 2024), then they won’t owe any federal income tax. However, as the employer, you are still expected to withhold federal income tax at the applicable rate calculated on Form W-4, which will need to be completed for your child. Also, your child will need to complete a tax return for the mandatory withholding to be refunded.
Be aware that states are not required to conform to federal income tax laws. As a result, filing and withholding requirements may vary from state to state.
Restrictions on Hiring a Child
The US Department of Labor (DOL) indicates that children of any age can work for businesses that are wholly owned by their parents. Children under 16 are prohibited from working in mining, manufacturing, or other industries that the DOL deems hazardous. Also, the DOL has additional restrictions on the timing and duration of job duties for children under 18. States may also have specific rules regarding child labor.
Frequently Asked Questions (FAQs)
Yes. You must still meet the general criteria for claiming a dependent, including the provision of more than half of the child’s support for the year.
The IRS does not dictate a minimum age for earning a salary. Laws setting a minimum age for employees generally do not apply to an owner’s children.
You do not have to issue a 1099 to your child if your child is an employee. If your child is an independent contractor and you paid them $600 or more for services during the year, you would need to issue your child a Form 1099. If they are an employee, you will need to issue them Form W-2.
Bottom Line
Paying your kids from your business can help you save taxes while not adding a tax burden for your child. When employing your children, don’t cut corners. Keep expectations, compensation, and documentation in line with what you would do with an outside employee. An IRS examiner would want to confirm that income was actually earned and not just an allowance. They may also want to verify that the compensation paid is reasonable. Your records should reflect compliance with those expectations.
