We're not talking about an allowance. Hiring your kids for your small business means tax savings.
If you’re the owner of a family business, there’s a good chance your kids will help out from time to time. How should you pay them, and what kind of tax advantages come with doing so?
The basics
- Your children can be officially employed by your business (if they’re doing real work)
- They can be paid up to the standard deduction ($12,950) tax-free
- Your business can take a $12k deduction without any tax liability on your child
- If you combine that with retirement funds, you can potentially deduct up to $18k from your taxable income per child
- Only available to certain business types, but a “family management company” can help you take advantage of these tax savings
Why hire your kids?
Officially hiring your kids isn’t just for convenient labor. Your business – and therefore your family – can save quite a bit on taxes this way.
To start off with, your child can take the standard deduction on their income taxes, which basically means they pay no income taxes on any wages up to $12,950. But you’re still able to deduct their wages from your taxable income as a business expense, meaning you can save on taxes without the money ever leaving your family.
If your business is a sole proprietorship, or a partnership in which each partner is a parent of the child, you also don’t have to withhold anything for payroll, Medicare, social security, or Federal Unemployment Tax Act (FUTA) taxes. This also includes LLCs which are taxed as sole proprietorships or partnerships (once again, as long as each partner is a parent of the child).
Retirement funds
Since your child will now have some earned income, you can claim additional tax deductions by contributing up to $6k to an IRA.
Combined with the wages you’re paying your children, you can deduct over $18k from your taxable income per child, plus getting them started early on a non-taxable nest egg. Not bad at all.
Other considerations
Is there any way to make this work with a corporation?
Normally, if your business is an S corp or C corp (or an LLC taxed as such), you can’t take advantage of these tax savings. However, there is a workaround: the family management company (or FMC).
To do this, you have to create a disregarded entity (or Single Member LLC) that exists alongside your business for the sole purpose of managing your kids. This is the FMC, and it’ll be responsible for hiring, scheduling, and monitoring your children.
Then you just set up a contract with your main business to pay the FMC for the work done by your children, free of any payroll taxes. It takes a little work to set up, but it’s not really any more complicated than setting up payroll taxes would be.
The IRS is pretty strict about the rules, but this is all perfectly above-board, so there’s nothing to worry about.
What about the “kiddie tax”?
Yes, that’s a real thing. And the IRS does actually call it the “kiddie tax” on their official website.
Designed to discourage the wealthy from dodging taxes by transferring assets to their kids, this rule taxes a child’s unearned income (like capital gains distributions, dividends, interest income, etc) at the parent’s tax rate if it’s over the annual limit ($2,300 in 2022). This applies to children under the age of 18 or full-time students under the age of 24.
But this only applies to unearned income. So if you’re paying your kids to do an actual, real job … no kiddie tax!
Helpful tips
- Your kids have to be doing actual (age-appropriate) work for the business. There’s a lot of flexibility on what counts as legitimate work, but you can’t just make up fake stuff for them to do.
- Pay them fair wages for their work. Basically, the same thing you’d pay anyone else to do that job.
- Write out a contract, record their hours, create a paper trail so the IRS can verify that everything is in order.
- Make sure you fill out IRS Form W-4 and USCIS Form I-9 for each kid.
- They also will need a proper W-2, like any other employee would.
| 📑Note: The I-9 is a document confirming that an employee is legally eligible to work in the United States. The W-4 is a document that establishes how much will be withheld from the employee’s wages for tax purposes. |
Bottom line
If you own a family business, hiring your kids is a great way to save on your tax bill while giving them a head start in life with some non-taxable income. As long as you’re following all of the IRS rules, you can save thousands on your taxes with no trouble. And giving them a little work ethic probably won’t hurt either.
Looking for assistance setting up your own FMC structure or implementing other great tax strategies? Schedule a call with one of our experts today.
