Why You Should Hire Your Children to Lower Your Taxes

Is hiring your kids a legitimate tax saving strategy?

Actually, yes — it is!

If you hire your children to do real work for your business, you may be able to lower your business income, your self-employment income and your effective income tax rate, and you can do this all while avoiding the kiddie tax.

The Benefits of Hiring Your Children

It can reduce business income.

You, as the business owner, can take a tax deduction for hiring your children because wages are tax deductible. If you pay wages to anybody — including your child — you can deduct those costs because they are legitimate business expenses. However, wages are only deductible if they are paid to bona fide employees, so make sure your child qualifies as a real employee and have the documentation to back it up.

It can reduce self-employment tax.

If you pay wages to your child and deduct those wages on the business’s tax return, less business income will flow through to you. This means you’ll have less self-employment income to report. In other words, by hiring your child, you can effectively convert business income into a business deduction, lowering both business earnings and self-employment tax.

Wages paid to children may not be subject to FICA.

When your business pays wages to your child, those wages will not be subject to FICA taxes (i.e., social security and Medicare tax) if both the following are true:

1. Your child is under age 18.
2. You own an unincorporated business (sole proprietorship, single-member LLC or partnership) where you and/or your child’s other parent are the sole owner(s).

If you own an S or C corporation, or if you’re in a partnership with partners other than your child’s other parent, these rules do not apply, and your child’s wages will be subject to FICA.

Wages paid to children under 21 are not subject to FUTA.

FUTA taxes (federal unemployment taxes) are not assessed on wages earned by a child under age 21 when those wages are paid by their parents. This is true whether the parents own a sole proprietorship, an LLC, a partnership, an S corporation or a C corporation. Once that child reaches age 21, their wages will be subject to FUTA.

Children are typically in lower income tax brackets.

Children and adults are subject to the same income tax rates, but most children — especially most minor children — earn less than their parents, which places them in a lower tax bracket. By shifting income from a parent to their child, the family unit will report less in taxes overall.

The tax savings become even clearer when you consider the standard deduction. Children who aren’t claimed as dependents can take a standard deduction of ,950 for 2022. This means that the child’s first $12,950 of income is taxed at 0% (yes, zero percent!), with amounts above that taxed at only 10%.

Earned income is not subject to kiddie tax.

The kiddie tax is often a concern when children start earning significant sums of money, but parents don’t need to worry – the kiddie tax is only relevant when minor children report unearned income, such as interest or trust income. Earned income from wages, salaries, tips and contracted work are not subject to the kiddie tax.

Retirement plans can allow for even more income shifting.

Additional savings are possible if you establish an IRA for your child. Your child can make a tax-deductible contribution to their IRA. The maximum limit is the lesser of the child’s annual wages or $6,000 (in 2022). Because this contribution is tax-deductible, you may be able to pay your child up to $18,950 (in 2022) at a 0% tax rate.

The Requirements

To successfully shift business income from your own tax bracket into your child’s tax bracket, you must follow a few key requirements.

Your child must be a bona fide employee.

Your child must be a true employee of your business. This means that:

• Their work must be related to the business. Your child must be doing work that benefits your business. You can’t pay your child to do household chores or run personal errands and successfully argue they are an employee.
• Their work must be ordinary and necessary for your business. Your child must be doing work that needs to be done. If your child wasn’t performing those job duties, would you hire somebody else to do the work, or perhaps do the work yourself? If so, your child is likely performing job duties that are ordinary and necessary.
• Payments must be made in relation to their work. You can only pay your child for the duties they perform. If you pay your child a set amount each week regardless how many hours they work, the IRS might view your payment as an allowance rather than compensation.

You must legally establish your child as an employee.

To establish your child as an employee, you must comply with state and local laws. This might mean:

• Applying for an employer identification number (EIN)
• Registering with your state’s Department of Labor
• Obtaining worker’s compensation
• Filing government paperwork, like:
  • Form W-4, Employee’s Withholding Certificate
  • Form I-9, Employment Eligibility Verification
  • Form 941, Employer’s Quarterly Federal Tax Return
• Keeping timecards
• Withholding and remitting income taxes
• Filing end-of-year payroll forms like Form W-2, Form W-3, Form 944 and Form 945
• Providing your child with appropriate lunch breaks
• Complying with the requirements of the Occupational Safety and Health Act (OSHA)

Their compensation must be reasonable for the work they’re doing.

The IRS knows that you benefit from shifting income to your child, so they will pay close attention to your child’s wages. If the wages you pay your child are too generous for the work they are performing, the IRS will disallow the deduction. It may be wise to keep records that you considered the reasonableness of your child’s wages. This can be as simple as saving a job listing that shows the hourly rate for similar positions in your area.

The Negative Impacts

Hiring your child as an employee can certainly save you taxes, but there are some downsides to this tax strategy.

Payroll

Many small business owners have little or no experience with payroll taxes. It can be challenging, overwhelming and time consuming to process payroll when you have no prior experience.

Compliance

Upon examination, your IRS agent will want to verify that the wages actually went to your child or were deposited into an account that benefits them. If you haven’t already done so, you may need to establish a bank account on their behalf.

Legal

Your child must be old enough to work. Contact your state to see if your child needs to obtain a work permit or age certificate.

Hiring Children Tax Strategy: Make It Part of Your Tax Plan

Hiring your children can be a great tax-saving tool, and if it’s something you’re considering, talk to your tax planner. Our Corvee Tax Planning software can show you how hiring your children will affect your tax return, so you can see if the tax savings is worth the effort.