How to Hire Your Kids and Save on Taxes This Year
Learning how to hire your kids to work in your business is an excellent way to save on taxes and build wealth.
However, hiring your children is not as easy as designating your preteen as the social media manager.
It requires legal compliance, accurate bookkeeping, and the willingness to usher in the next generation.
Let’s break down what you need to know to hire your kids and save on taxes this year.
How does it work?
Your business can employ children ages 7-22. You can pay your children an annual salary or invest some of their pay to maximize the benefit.
You can pay each of your children up to $13,850 per year. This amount equals the standard deduction for single individuals. (Remember to deduct the payment on your business taxes to decrease your taxable income.)
You will need to file a tax return for your child. If they made $13,850 or less, their taxable income is 0.
You can split your child’s pay into income and investments such as a Roth IRA to maximize your tax benefits.
If you put $5,000 in an IRA and paid them $13,000 in wages, their taxable income would still be 0.
Pros and cons of hiring your kids
It’s vital to weigh the pros and cons of hiring your kids for your own business tasks. While the tax benefits are tempting, the risk may outweigh any financial kickbacks you may receive.
Pros
Tax benefits
When parents set up a sole proprietorship or single-member LLC, kids employed in a parent-owned business do not have to pay Social Security or Medicare taxes.
Kids’ salaries can be deducted from business income, reducing taxable profit. Your child’s income is taxed at the child’s tax rate, which may be lower than yours, depending on the tax bracket.
Assets can be transferred through wages you pay your children.
The wages can be placed into a savings account under your child’s name, an education savings account, or a ROTH IRA. Doing so allows you to transfer wealth without paying gift or estate taxes.
FYI, if you run an S Corp or C Corp, the IRS rules for hiring your kids are different than if you claim a sole proprietorship or LLC.
With S Corp and C Corp, you must pay payroll taxes on your children’s salaries, negating the most significant tax benefit.
Life skills
Give your kids a head start on learning entrepreneurial skills such as financial literacy, goal-setting, and discipline.
Keep it in the family
If you want to pass on your business to your children one day, getting them involved in the company now can help prepare them for future leadership opportunities.
While work must be appropriate for your child’s age and skill level, starting them in the business early can aid in succession planning.
Cons
The rules aren’t straightforward
You will need to check child labor laws frequently (both federal and state). Depending on your industry, work may not be suitable for children under a certain age.
The Fair Labor Standards Act (FLSA) monitors employed children to ensure their safety and meet education standards. THE FLSA and IRS could deem your child’s work illegitimate, forcing you to amend your tax returns and lose the savings benefits.
Wages must be reasonable
If your child works for your business, you must pay them the same salary as a standard employee.
Increased chance of an IRS audit
Hiring your children can increase the risk of an IRS audit. Since this tax benefit is widely abused, the IRS is on the lookout.
The child is not ready for work
Collecting tax benefits as young as seven might seem tempting, but do you have an appropriate job for a seven-year-old?
Starting children in a work environment too young could have negative impacts later in life.
How to do it the RIGHT way
Do provide your child with legitimate, safe work.
You can’t hire your child to do dangerous tasks or not complete any work at all. The US Department of Labor provides child labor laws to define your kids’ rights.
Create an employment contract that clearly states their responsibilities. You’ll need this documentation if you are chosen for an audit.
Do pay real wages.
Paying slightly more than minimum wage for weekly work will help you provide your child with a regular payroll sheet.
Don’t mix personal with business.
If you give your child an allowance for doing chores around the house, this money should be separate from the wages you pay for your business.
Don’t pay your kid in cash.
Always pay your children with a check or ACH, so you have a paper trail. It’s also wise to have a separate bank account for your child so you can easily track transactions.
5 steps to hire your kids
- Before you can hire employees, you need an Employer Identification Number (EIN). The EIN is required for business and tax documents.
- You must complete Form W-4 and state W-4 forms to hire your child. Keep these on file in case of an audit. You must also complete Form I-9, which verifies your employees’ identity and work eligibility. Consult the IRS regarding employee onboarding documents. Your child should be treated like any other employee.
- Any children under 18 must follow child labor laws, including job specifications, hours, and how they are paid.
- You must pay your child in real, reasonable wages. Their pay cannot be substituted for food, education expenses, etc.
- Keep detailed payroll records in case of audit—deposit wages into a separate bank account for your child to maintain a paper trail. Please help your child fill out their taxes so you can keep accurate records for your business and take advantage of tax benefits.
Is your business a good fit?
Running a small business can incur many costs, including a significant tax bill.
Learning how to hire your kids can help alleviate the tax burden while assisting them in appreciating the family business.
However, it would be best if you educated yourself on tax compliance and fully understand the pros and cons to ensure it’s right for you. Reach out to a CPA for more questions.
