Business owners hire their children for several reasons, such as instilling a strong work ethic, teaching responsibility, encouraging entrepreneurship, saving on taxes, and helping save for college. These benefits are the result of the Tax Cuts and Jobs Act of 2018 (TCJA) and subsequent updates. If you own a business and have children under age 18, you can use the TCJA to lower your income and payroll taxes and realize savings and benefits for you and your children.
Tax Benefits of Hiring Children
As a business owner, you’re allowed to hire and pay wages to your child. In doing so, you’ll transfer some of your income, which is taxed at a high rate, to your child, who is taxed at a lower or zero rate, thereby reducing the amount of taxes owed.
Benefits to business owner families include:
- Your child can be employed by your business to do legitimate work. Assuming that they’re paid an annual wage $12,550, this amount is equal to the standard deduction for the child as a single individual. This means that the net effect to them is zero income and zero taxes due. You can pay more than $12,550 in wages to your child and the excess will be taxable at the child’s low tax bracket, usually 10%.
- Your business treats wages as an expense and so receives a deduction for wages paid to your child, decreasing your Federal and state taxable income by your tax bracket times the child’s wages.
- You don’t need to pay Social Security and Medicare (FICA) payroll taxes for children employed in your business if it is a sole-proprietorship, single-member LLC, or an LLC taxed as a partnership owned by you and your spouse. There’s no FICA exemption for employing a child in an incorporated business (S or C Corp) or in a partnership that includes non-parent partners. In these situations, the child is subject to the same payroll tax rules as all other employees. However, there’s a way around this restriction by paying your child’s wages out of a Family Management Company instead of directly from your business. The new entity would enter into a management contract with your business and it would pay your children instead your business’s payroll.
Savings Benefits of Hiring Children
Your child can use the wages earned from his or her job in your business to save for college. The accumulation of funds for college may be accelerated by choosing a college savings plan instead of a traditional bank account or savings instrument. Please refer to previous posts in which we have provided details on the characteristics and advantages of a range of college savings plans and accounts.
Instead of a college savings plan, your child may prefer to set up and contribute to a Roth IRA. The power of compounding over several decades is impressive, as indicated below in “Examples of the Effects of Hiring a Child”. The only requirement for your child to be able to make an annual Roth IRA contribution is to have earned income in the year that at least equals the amount contributed. Age is irrelevant. If a student earns wages from a summer job, a part-time job after school, or a job in your business, he or she is eligible to make Roth IRA contributions. Hiring your child can enhance the child’s IRA and the family’s business in other ways as indicated below in “Examples of the Effects of Hiring a Child”.
Types of Jobs
For those families who own and manage a farm, hiring children is common and has potentially greater rewards that those available to other business owners. The range of jobs that are suitable for children on a farm is extensive, and chances are that the children would be performing some of them anyway.
For non-farm owners, there are also many jobs that children can perform in your business. You can pay the same wage rate to them that you would need to pay any other employee or contractor to do the same work. Examples include:
- Cleaning the workplace after hours
- Washing company vehicles
- Updating customer lists and databases
- General business operations data entry and verification
- Transcribing video and audio recordings
- General off-site errands such as trips to the post office
- Helping at meetings by passing out documents and setting up equipment
- Distribution of ad fliers and coupons
- Updating your website and social media accounts
To employ your children within IRS regulations, ensure that they are performing legitimate work and have accurate position descriptions for their jobs. Track their hours and record the tasks performed. Be sure that the work is age-appropriate. Pay them a reasonable wage for the work performed. Fourteen is the minimum age at which you can legally employ children according to the Fair Labor Standards Act, but there are exceptions allowed for younger children depending upon the nature of the work.
Your best source for compliance information is IRS Publication 929 - Tax Rules for Children and Dependents. The latest edition is for Tax Year 2021. If you’re considering hiring your children to work in your business and you wish to be apprised of developments since the last edition of Publication 929, such as legislation enacted after it was published, refer online to IRS.gov/Pub929.
Examples of the Effects of Hiring a Child:
Let’s look at a parent in the 37% tax bracket who owns an unincorporated business. He hires his child and pays the child $16,000 for the year. He reduces his income by $16,000, which saves him $5,920 in Federal income tax (37% of $16,000). His child has a taxable income of $3,450 ($16,000 less the $12,550 standard deduction), on which the taxes owed are $345 (10% as the child’s tax bracket times $3,450).
If the child is under age 18, he or she is not subject to FICA payroll taxes since employment for FICA purposes doesn’t affect a child under the age of 18 employed by an unincorporated business owned by a parent. Thus, the child will not be required to pay the employee’s share of the annual FICA taxes of $1,200 (7.65%) and the parent-business owner will save $1,200, which is its half (7.65%) of FICA payroll taxes.
To size the potential benefits to IRA accounts, let’s assume that a 15-year-old had contributed $1,000 from wages to a Roth IRA at the end of each of the four years ending in 2022. If the annual rate of return on these funds is 5%, this $4,000 contribution to the IRA, without any additional contributions, would be worth about $33,000 (in 2022 dollars) when the child turns 60 in 2067.
As another example of IRA benefits, assume that a child was paid $12,550 as an annual salary. The parent-business owner could also put an additional $6,275 (50% of salary) into a deductible Roth IRA for the child. The child’s income taxes owed would remain at zero as described above, but the business would be able to deduct $18,825 for the child’s wages of $12,550 plus the 50% IRA contribution of $6,275, without incurring additional taxable income for the business.
Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS). Securities products and advisory services offered through PAS, member FINRA, SIPC. Financial Representative of The Guardian Life Insurance Company of America® (Guardian), New York, NY. PAS is a wholly owned subsidiary of Guardian. Consolidated Planning, Inc. is not an affiliate or subsidiary of PAS or Guardian. CA Insurance License Number - 0M50974. Guardian and its subsidiaries do not issue nor advise with regard to student loans. This material contains the opinions of the author but not necessarily those of PAS or Guardian. Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation. For informational purposes only. 2022-141495 (Exp. 8/24)