Can I Hire My Kids Through My Business for Tax Savings?

Hiring your children through your business is one of the most effective family tax planning strategies available. When structured correctly, it allows you to shift income from your higher tax bracket to your child's lower bracket -- or potentially zero bracket -- while generating a legitimate business deduction. The key is ensuring the arrangement complies with IRS rules regarding bona fide employment, reasonable compensation, and applicable payroll tax exemptions under IRC Section 3121(b)(3)(A).

The Payroll Tax Exemption for Children Under 18

Under IRC Section 3121(b)(3)(A), wages paid to a child under age 18 who is employed by a parent's sole proprietorship or a partnership where each partner is a parent of the child are exempt from Social Security and Medicare taxes (FICA). This exemption also extends to Federal Unemployment Tax (FUTA) for children under 21 under IRC Section 3306(c)(5). This means that a sole proprietor who hires their 14-year-old child can pay wages that are free of the combined 15.3% FICA tax and 6% FUTA tax -- a significant savings.

However, this exemption does not apply when the child is employed by a corporation -- including an S-Corp or C-Corp -- or by a partnership that includes non-parent partners. If your business operates as an S-Corp, wages paid to your child are subject to standard payroll taxes regardless of the child's age. Some practitioners recommend a workaround where the S-Corp contracts with a sole proprietorship owned by the parent, and the sole proprietorship hires the child. This structure must have genuine economic substance beyond tax avoidance to withstand IRS scrutiny.

Income Shifting Benefits

For 2024, the standard deduction for a dependent who earns wages is the greater of $1,300 or the dependent's earned income plus $450, up to the regular standard deduction of $14,600. This means a child who earns $14,600 or less in wages pays zero federal income tax. Even if the child earns more, the first $11,600 of taxable income (after the standard deduction) is taxed at only 10%, and the next bracket is 12%. Compare this to a business owner in the 32% or 37% bracket, and the tax savings from shifting $14,600 in income can exceed $5,000 in federal taxes alone, plus state taxes.

Additionally, the child's earned income can be contributed to a Roth IRA -- up to the lesser of their earned income or $7,000 for 2024. A Roth IRA contribution for a teenager creates decades of tax-free growth. A $7,000 contribution at age 14 growing at 8% annually would be worth approximately $217,000 by age 59-and-a-half -- all tax-free.

Requirements for Legitimate Employment

The IRS requires that the employment arrangement be genuine. Your child must perform real work that provides value to the business. Acceptable jobs include filing, data entry, cleaning the office, managing social media accounts, organizing inventory, answering phones, assembling materials, and other tasks appropriate for the child's age and abilities. The compensation must be reasonable for the work performed -- paying a 10-year-old $50 per hour to sweep floors will not withstand audit scrutiny.

Document the employment relationship with the same formality you would use for any employee. Complete a W-4 form, maintain timesheets or a time-tracking system, issue regular paychecks from the business account (not cash), file Form W-2 at year-end, and comply with applicable state child labor laws. Many states restrict the hours and types of work for minors under 16, and some require work permits. Federal child labor laws under the Fair Labor Standards Act also apply, although children employed by their parents in non-hazardous occupations are largely exempt from federal restrictions.

Reasonable Compensation Standards

The IRS evaluates reasonable compensation based on what you would pay an unrelated person to perform the same work. Research local wage rates for similar positions. If a local office assistant earns $12 to $18 per hour, paying your child within that range is defensible. Paying $40 per hour for basic administrative tasks is not. Keep your compensation analysis in your records so you can demonstrate the basis for the wage rate if questioned.

State Law Considerations

State child labor laws vary significantly. Some states prohibit employment of children under 14 in any capacity, while others allow parental employment with fewer restrictions. Check your state's department of labor regulations before hiring your child. Additionally, some states require you to carry workers' compensation insurance for any employee, including family members. Failure to comply with state employment laws can result in penalties that outweigh the tax savings.

Hiring your children is a strategy that combines legitimate tax savings with the added benefit of teaching financial responsibility and work ethic. AE Tax Advisors helps business owners structure these arrangements to maximize tax benefits while maintaining full compliance with federal and state requirements.

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This article is for informational purposes only and does not constitute legal or tax advice. Consult a qualified tax professional regarding your specific circumstances. AE Tax Advisors, 935 Lake Elmo Dr, Suite B, Billings, MT 59105. Phone: (631) 614-5762.