How to Hire Your Children To Work For Your Business and Save On Taxes

Important Notice: The content provided on this website is for educational purposes only and is not intended as professional advice. It is not a substitute for personalized consultations with one of our skilled CPAs. Our firm does not support the general application of the strategies discussed, as they may not apply to your specific tax situation. Before taking any actions, it is crucial that you consult with an experienced CPA who can evaluate your unique financial circumstances. For tailored advice, please contact us at 970-949-1015 or email hello@mckelveyinc.com. You can also schedule a free consultation with our team through our scheduling link. We are here to help ensure your financial decisions are well-informed and compliant with current tax laws.

Hiring your children to work for your business is a tax-saving strategy that has been used by many savvy business owners. By paying your child for legitimate work, you can reduce your taxable income and shift some of your earnings to lower tax brackets—helping your family save money in a legal and effective way. This strategy can be particularly beneficial for S-corp and small business owners in Colorado and elsewhere, especially when properly managed to comply with IRS regulations.

Why Hiring Your Child Saves Taxes

The IRS allows business owners to hire their children and pay them a reasonable wage for the work they perform. This wage is fully deductible as a business expense, meaning that you can subtract it from your company’s income, reducing your overall tax liability.

Let’s break down how this works:

• Income Shifting: Shifting income from a higher tax bracket (yours) to a lower or zero tax bracket (your child’s) is one of the most effective ways to reduce your tax burden. For example, the federal standard deduction for 2024 is $14,600. If your child earns below this threshold, they will pay no federal income tax. This provides a perfect opportunity to move a portion of your income from your higher bracket to your child’s lower one.
• FICA and FUTA Exemption: If your child is under 18 and works for a parent’s sole proprietorship or partnership (where both partners are the child’s parents), their wages are not subject to Social Security and Medicare taxes (FICA) or federal unemployment tax (FUTA). This means neither you nor your child will have to contribute to these payroll taxes, which further increases the overall tax savings.
• Reasonable Compensation: The IRS stipulates that the wages paid to your child must be for real work and be reasonable based on the work performed. For example, you cannot pay your child $50,000 a year to clean the office for an hour a week. However, you can pay them a reasonable rate for clerical work, filing, or even marketing tasks like social media management if they’re genuinely contributing to the business.

Real Work Requirement

It is essential to ensure that your child is performing actual work for your business. The IRS scrutinizes payments made to family members to prevent abuse of tax laws. The work your child does should be something that would normally require you to hire someone else if they weren’t doing it. Some examples of tasks children could realistically perform for a business include:

• Clerical work, such as filing, scanning, and data entry.
• Running errands or managing deliveries.
• Helping with social media or content creation (e.g., taking product photos or posting updates).
• Cleaning the office or workspace.
• Assisting with customer service.

You should also keep documentation of the work your child is doing, including a job description, timesheets, and any other records that substantiate the duties they perform. This ensures that you’re covered in case the IRS ever questions the legitimacy of the arrangement.

Record Keeping and Compliance

Good record-keeping is critical to making this strategy work. The IRS requires documentation to prove that your child’s employment is legitimate, and that the wages paid are for services actually rendered. Here are some steps you should take:

• Timesheets: Keep timesheets for your child just as you would for any other employee. This should detail the hours worked and the tasks completed.
• Job Description: Have a job description outlining your child’s role in the business. This will help show that they’re performing legitimate work that justifies their wages.
• Pay a Reasonable Wage: Pay your child a wage that is reasonable for the type of work they’re doing. You can research similar positions in your area to ensure the wage is in line with what you’d pay a non-family member for the same work.

When done correctly, this can provide tax savings and help teach your child valuable skills, such as responsibility and money management. However, failing to document everything properly or paying your child an unreasonable wage could lead to IRS penalties.

Family Management Company Strategy

Some business owners choose to take this strategy a step further by setting up a family management company. This is typically a sole proprietorship owned by the parents, which then contracts with the original business (like an S-corp) to provide management services. The family management company can then pay wages to the children for services rendered.

Here’s how this works:

• Your S-corp would pay a management fee to the family management company.
• The family management company would pay wages to the children for tasks such as scheduling appointments or managing household-related business matters.

This structure provides added flexibility and might allow the family management company to handle tasks that don’t strictly relate to the core business of the S-corp. However, it’s essential that the management company operates as a legitimate business, including having a separate bank account, filing appropriate tax forms, and keeping detailed records of all payments and services rendered.

The family management company should obtain its own EIN (Employer Identification Number) and be registered with the state to operate as a business. Just as with hiring your child directly through the S-corp, the work must be legitimate, and the wages reasonable. Without these steps, the IRS could deem the payments as non-deductible or apply penalties.

Benefits Beyond Taxes

In addition to the tax savings, hiring your children can offer other benefits. It gives them real-world work experience, teaches them about money management, and fosters responsibility. They learn valuable skills that can serve them well in future jobs or careers.

The money they earn can also be invested in long-term savings strategies, such as a Roth IRA. Since the earnings are legitimate wages, your child can contribute to a Roth IRA, which grows tax-free. This could help set them up for a solid financial future while you enjoy the immediate tax benefits.

FAQ

What is the maximum I can pay my child without them paying income tax? For 2024, the standard deduction for a dependent is $14,600. If your child earns less than this, they will not owe federal income taxes.

Do I have to withhold FICA or FUTA taxes if I hire my child? If your child is under 18 and works for your sole proprietorship, their wages are exempt from Social Security and Medicare (FICA) taxes and federal unemployment taxes (FUTA).

Can my S-corp hire my child directly? Yes, but in that case, the wages will be subject to FICA taxes, which could reduce the overall tax benefit. This is why some business owners use a family management company (a sole proprietorship) as an intermediary to avoid FICA taxes.

What kind of work can my child do for my business? Your child must perform real work for your business to justify their wages. Examples include but are not limited to clerical work, social media management, running errands, and customer service.

Do I need to keep records of my child’s work? Yes, it’s essential to maintain detailed records, including timesheets and a job description. These documents will help prove that your child’s employment is legitimate if the IRS ever questions the arrangement.

Does my child have to file a tax return? If your child earns more than the standard deduction, they will need to file a tax return. However, if they earn less, they are not required to file.

Can my child’s earnings be invested in a Roth IRA? Yes. Since your child’s earnings are legitimate wages, they can contribute to a Roth IRA, which allows their investments to grow tax-free.

Final Thoughts

Hiring your children can be a highly effective tax-saving strategy for business owners, but it must be done correctly. Detailed records, reasonable wages, and legitimate work are key to ensuring that you remain compliant with IRS guidelines. If you have any questions or want to explore how this strategy could work for your family, our team of CPAs is here to help.

If you’re looking for ways to save on taxes and build wealth, our team of experienced CPAs can help. We specialize in strategies tailored to your unique financial situation, ensuring you maximize savings and keep more of what you earn. Don’t leave money on the table—reach out to us today at 970-949-1015 or hello@mckelveyinc.com to learn how we can guide you toward greater financial success.