Paying your children through your business is a strategy some family-owned companies use to reduce their overall tax burden. But is it legal? And if so, how can you do it correctly without running afoul of tax laws? This post explores the rules, benefits, and practical steps for paying your kids through your business while staying compliant.
Understanding the Basics of Paying Your Children Through Your Business
The IRS allows business owners to pay their children wages for legitimate work performed. This can shift income from a higher tax bracket (the parent’s) to a lower one (the child’s), potentially reducing the family’s overall tax liability. However, the key word is legitimate. The child must actually perform work that is reasonable for their age and the business needs.
Who Qualifies as a Child Employee?
Your biological child, stepchild, or adopted child.
Children under 18 can be employed in a family business without paying Social Security and Medicare taxes if the business is a sole proprietorship or a partnership owned only by the parents.
Children 18 and older are subject to the same tax rules as other employees.
Types of Businesses That Can Pay Children
Sole proprietorships
Partnerships where both parents are partners
Corporations and LLCs can also pay children, but different tax rules apply, including payroll taxes.
What Work Can Your Children Do?
The IRS expects the work to be age-appropriate and necessary for the business. Examples include:
Filing and organizing paperwork
Answering phones or customer service tasks
Cleaning or maintenance
Assisting with social media or marketing (if age-appropriate)
Running errands or stocking inventory
For younger children, simple tasks like shredding documents or stuffing envelopes may qualify. The work should be documented with timesheets or work logs.
How Much Can You Pay Your Children?
The wages must be reasonable for the work performed. Paying a child $15 per hour for simple filing might raise red flags. The IRS expects pay rates similar to what you would pay a non-family employee for the same job.
Tax Benefits of Paying Your Children
Income shifting: Moving income to children who likely have little or no other income means they pay little or no federal income tax on their wages.
Payroll tax savings: For children under 18 working for a sole proprietorship or partnership owned by their parents, Social Security and Medicare taxes do not apply.
Retirement savings: Children can contribute to an IRA with their earned income, starting their retirement savings early.
Standard deduction use: Children can use their standard deduction to shelter some or all of their wages from federal income tax.
Important Compliance Tips
To avoid IRS scrutiny, follow these guidelines:
Keep detailed records: Timesheets, job descriptions, and pay stubs.
Use a formal payroll system: Pay through payroll, with proper withholding and reporting.
Issue a W-2: Report wages paid to your children.
Avoid overpaying: Pay fair market wages for the work done.
Document the business need: Be able to explain why the work was necessary.
Examples of Paying Children Through a Business
Example 1: Sole Proprietor with a Teenager
Jane owns a small landscaping business as a sole proprietor. She hires her 16-year-old son to help with office tasks like answering phones and scheduling appointments. She pays him $10 per hour, and he works 10 hours a week during the summer. Jane pays him through payroll, issues a W-2, and deducts his wages as a business expense. Her son uses his earnings to contribute to a Roth IRA.
Example 2: Family Partnership
John and Mary run a partnership business. They hire their 14-year-old daughter to help with inventory management and cleaning. Since the business is owned only by the parents, they do not withhold Social Security or Medicare taxes for their daughter. They pay her a reasonable wage and keep records of her hours and duties.
When Not to Pay Your Children Through Your Business
If the child is not performing real work.
If the wages are excessive or unreasonable.
If the business is a corporation or LLC and you want to avoid payroll taxes improperly.
If you cannot document the work and payments properly.
Final Thoughts on Paying Your Children Through Your Business
Paying your children through your business can offer real tax benefits when done correctly. It requires careful planning, documentation, and adherence to IRS rules. The work must be real, the pay reasonable, and the process transparent. Families who follow these guidelines can reduce their tax burden while teaching children valuable work skills and financial responsibility.
If you are considering this strategy, consult a tax professional to ensure compliance with current tax laws and to maximize the benefits for your family.
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Schedule a ConsultationThis article is for general information only and is not tax or legal advice for your specific situation.