Can Hiring Your Child Save You Money on Taxes?

What if paying your child to work in your business could potentially reduce your taxes while helping your child start building wealth?

It can be a legitimate strategy, but there are important rules you need to understand before putting it into place.

If you own a business and have children, hiring them can potentially provide tax benefits while also teaching valuable lessons about work, money, saving, and investing. However, the tax treatment depends on several factors—including your business structure, your child’s age, and the type of work they perform.

Your Business Structure Matters

One of the biggest factors to consider is how your business is structured.

If you operate as a sole proprietorship, there can be significant payroll tax advantages when employing your child, particularly when your child is under age 18. In certain circumstances, wages paid to a child under 18 may not be subject to Social Security and Medicare taxes. Wages paid to a child under age 21 may also be exempt from federal unemployment tax in certain circumstances. Similar special rules may apply to certain partnerships when both partners are the child's parents.

What About Corporations?

If your business operates as a corporation, including an S corporation or C corporation, those special payroll tax exemptions generally don't apply simply because the employee is your child. In other words, you shouldn't assume that your child's wages are automatically exempt from Social Security, Medicare, or unemployment taxes just because you own the business. The business entity itself plays an important role in determining how the wages are treated.

Your Child Must Actually Work

Hiring your child isn't simply a way to move money from your business to your child. Your child needs to actually perform legitimate work for the business, and the work should be appropriate for their age and abilities.

Depending on your business, that could include tasks such as:

• Filing and organizing
• Cleaning
• Administrative work
• Preparing materials
• Social media assistance
• Other legitimate business tasks

The amount you pay should also be reasonable for the work performed. You should be able to explain why your child was paid that amount based on their responsibilities, hours, skills, and the type of work they completed.

Don't Forget the Bookkeeping and Documentation

This is an area where proper bookkeeping becomes especially important.

Treat your child's employment like a legitimate employment arrangement. Keep records of:

• The work your child performs
• Hours worked
• Rate of pay
• Payroll records
• Other required employment documentation

If you have other employees, your child shouldn't simply be exempt from your normal processes. Good documentation helps demonstrate that the employment arrangement is legitimate and that the wages paid are reasonable for the work performed.

What Are the Potential Benefits?

When done properly, your business may be able to deduct reasonable wages as a business expense, while your child earns legitimate income. Depending on the circumstances, your child may also be able to use that earned income to begin saving for retirement, including potentially contributing to a Roth IRA.

But the benefits aren't just financial.

Your child can gain real-world experience by:

• Earning their own money
• Understanding how a paycheck works
• Learning how to save
• Developing money-management skills
• Potentially starting to invest at a young age

Those lessons can be incredibly valuable long after the tax benefits are gone.

Consider the Bigger Financial Picture

There are other factors to consider before hiring your child. Your child's income and assets could potentially affect college financial aid or other programs that consider financial resources.

You also need to consider their total income. While they may be able to earn up to the standard deduction without being subject to federal income tax, other earnings can affect the overall tax situation.

Rules can vary based on your business structure and individual circumstances, so it's important to discuss your situation with your tax professional before implementing this strategy.

Plan Before You Pay

One of the biggest mistakes you can make is trying to put this strategy together after the fact. You don't want to reach the end of the year, realize you could have hired your child, and then attempt to create payroll records for work that wasn't properly documented.

Instead, plan ahead.

Before your child starts working:

1. Determine what legitimate work they can perform.
2. Establish reasonable compensation.
3. Understand the payroll requirements that apply to your business.
4. Set up the appropriate payroll and recordkeeping.
5. Keep accurate records once the work begins.

Before moving forward, talk with your tax professional and make sure you understand the rules that apply to your specific business and situation.

Have questions about bookkeeping, payroll, or keeping your business finances organized? Affordable Bookkeeping and Payroll Services is here to help you gain more confidence, more time, and more freedom in your business.