Hiring Your Children in the Family Business: Tax Rules

A family business may deduct reasonable wages paid to a child for real work. The child reports earned income, may use the standard deduction, and can potentially fund a Roth IRA. The planning is legitimate when the employment is legitimate.

The most common mistake is assuming that wages paid to a child are always exempt from payroll tax. The federal employment-tax treatment changes when the employer is a corporation or a partnership that includes someone other than the child's parents.

The Child Must Be a Real Employee

Assign duties appropriate to the child's age and the business, such as filing, inventory counts, social-media assistance, property photography, data entry, cleaning, or basic administrative work. Create a job description, track hours, supervise the work, and pay a market rate for comparable services.

Payments should run through the business books and a bank account controlled for the child's benefit. Large round-number payments made only on December 31, without time records or work product, are difficult to defend as compensation.

Payroll-Tax Treatment Depends on the Employer

When a parent operates a sole proprietorship, wages paid to a child under age 18 are generally not subject to Social Security and Medicare taxes, and wages paid to a child under age 21 are generally not subject to federal unemployment tax. Similar treatment can apply to a partnership only when each partner is a parent of the child.

Those parent-child exemptions generally do not apply when the employer is a corporation, including an S corporation or C corporation, or when a partnership includes a nonparent partner. Corporate wages are generally subject to income-tax withholding, Social Security, Medicare, and federal unemployment rules in the same manner as wages paid to other employees.

Income Tax and Roth IRA Opportunities

Wages are earned income to the child. Depending on the amount and the child's other income, the standard deduction may shelter some or all of the wages from federal income tax. Earned income can also support an IRA contribution, subject to the annual contribution limit and the amount of compensation.

The kiddie-tax rules primarily address unearned income, not reasonable wages for services. Moving investment income to a child is different from paying compensation. The business deduction and the child's wage reporting must match.

Reasonable Compensation

Reasonableness is based on the value of the work, not the tax result the family wants. Document comparable hourly rates, the child's skill level, hours worked, and the work produced. A teenager managing a meaningful video-editing workflow may command more than a younger child performing occasional office tasks.

Implementation Checklist

Complete hiring documents, comply with state child-labor rules, run payroll on schedule, issue Form W-2, retain timesheets and work product, and make payments to the child. Coordinate any retirement contribution with actual W-2 compensation. Revisit the role and rate as responsibilities change.

Worked Example: Marketing and Administrative Role

A 16-year-old works eight hours per week photographing inventory, editing short videos, organizing digital files, and preparing approved social posts. The business keeps timesheets and work samples and pays the same hourly rate it would pay an entry-level assistant. Payroll runs every two weeks into the child's account, and Form W-2 is issued at year-end. Those facts support a wage deduction.

If the employer is the parent's S corporation, normal corporate employment taxes generally apply even though the same wages might receive parent-child payroll-tax exemptions in a sole proprietorship. Converting an established S corporation to a sole proprietorship solely to avoid payroll tax usually creates larger legal and tax consequences than the savings.

State child-labor limits can restrict hours, occupations, and work during school. Federal tax treatment does not override those rules. The employment file should include any required work permits and parental or school documentation.

Frequently Asked Questions

Are wages paid to my child always free from payroll tax?

No. The parent-child exemptions generally apply to a sole proprietorship and certain parent-only partnerships. They generally do not apply when the employer is an S corporation or C corporation.

Can my child fund a Roth IRA?

Earned income from bona fide employment can support an IRA contribution, limited by the annual contribution limit and the child's compensation.

How much can I pay?

Pay a reasonable market rate for actual services. Age, skill, duties, time, and comparable wages matter more than the family's desired deduction.

Hiring Your Children in the Family Business: Payroll, Documentation, and Entity Rules