If you are a business owner and you want to make sure your family can be a part of how you grow your business while benefiting from the tax code, you may have heard about hiring your children to work in your industry.
Today, I’m going to explain everything that you need to know about putting your children on the payroll through an LLC, what to do if your business is set up as an S corp, and all the pertinent rules and regulations to follow so that you stay in good standing with the Internal Revenue Service (IRS).
Is hiring your children a legitimate tax strategy?
Yes, it is. In fact, the IRS incentivizes business owners to do so. Working at a young age teaches valuable life and business skills, helps kids learn the value of hard work, and can even contribute to the ongoing success of multi-generational family companies. So, how do we do this the right way?
Let’s talk about tax savings with an LLC: typical employees versus hiring your children.
Normally, when you hire an employee for your LLC, you’ll have to pay payroll taxes on their wages, including FICA taxes.
FICA includes social security, Medicare, and unemployment taxes: this breaks down to 6.2% for social security, 1.45% for Medicare, and about 0.6% to 6% for unemployment, depending on the state in which the business is located.¹
If you have a sole proprietorship, a single member LLC taxed as a disregarded entity, or even an LLC taxed as a partnership that is owned only by you and your spouse, then you can hire your children to work at your LLC, and the IRS provides several key tax breaks that you’ll be able to receive every single year.
Here’s what you need to know to take advantage of payroll tax savings.
When you hire children under the age of 18 to work for your LLC, they can earn up to $14,600 in income and pay zero federal income taxes on it in the upcoming tax year.
Let’s say your child is over the age of 18 but under 21. When you hire them, you will have to pay Social Security and Medicare taxes, but you won’t have to pay unemployment taxes.
Let me give you an example.
- You want to hire your 16-year-old child to work at your family business during the summer.
- Over the summer, you will pay him or her $10,000 for the year without the tax breaks.
Now, if you brought in a regular employee, you would have to pay 6.2% in social security, which would be about $620, and 1.45% in Medicare, which would be about $145.
And let’s say that you had 1% for unemployment, which would result another $100 in taxes.
Overall, due to the tax breaks that the IRS allows for you to hire your children inside of an LLC, you would save $865 by not having to pay FICA taxes.
What about multiple children?
Let’s say you’re hiring them for long-term work under your LLC. Tax savings can add up, but that’s not even including the tax savings that you’re receiving by taking the deduction against your ordinary income. In this case, you would also get to deduct the $10,000 that you paid your son or your daughter as a business expense, which would lead to some additional tax savings. (And this amount is for the year of 2024.)
Here’s what I recommend for S corp owners who want to hire their children.
Now, a lot of my clients operate S corps. Here’s what I need you to know about adding your children to the payroll.
Unlike LLC owners, S corp owners have to pay payroll taxes for their children, even if the children are under the age of 18. You’ll be contributing to FICA, which is Social Security and Medicare. We learned earlier that FICA is 6.2% on the Social Security side and 1.45% on the Medicare side. You want to avoid paying those taxes, especially if you have multiple kids.
For this reason, I recommend S corp owners set up an LLC management company if they intend to add their children to the payroll. Once the management company is set up, the S corp can pay a management fee to the LLC, and the children can be added to the payroll underneath the LLC.
So, you may choose to pay your children through the profits of the S corp in the following manner:
- Pay a management fee over to the LLC.
- That money leaves the S corp bank account.
- It is paid into an LLC management company that you establish with your children on its payroll.
The standard deduction is $14,600.² So, if you have three children, you might be able to move over just enough money to pay those three children through the management company. In this case, it would be $43,800 that we would move over in management fees in order to pay out our three children; this is how you, as an S corp owner or shareholder, can pay your kids with a payroll deduction and without incurring additional tax liability.
How old do children have to be to work for your business?
According to the Fair Labor Standards Act (FLSA), the minimum age to work in the United States is 14 years old in most, but not all, cases.³ Many clients of mine will employ their children before the age of 18 because those children have an active role in what their parents are trying to accomplish for the business.
The FLSA includes the following restrictions:
- The number of hours children under the age of 16 work per week and when they can work those hours.
- The types of hazardous jobs that children under the age of 18 may not work in.
For example, 14-year-olds and 15-year-olds are not allowed to work during school hours, more than 18 hours per week, or more than eight hours per day, even on holidays or weekends.³
Some of the hazardous jobs include forestry, construction involving roofing, trenching, or excavating, and operating dangerous machinery such as a forklift or trash compactor. In other words, construction, fabrication, tree care, and the like are not going to pass muster with the IRS or the federal laws on child labor.
Be careful, folks.
Follow these three rules if you want to bring your kids on the business’s payroll successfully.
Business owners who ignore the specifics or do not consult a qualified tax professional frequently run afoul of the IRS and may inadvertently commit tax fraud.
Here’s the solution:
Rule #1: Find a job in your business you can hire your child to actually do.
Rule #2: Pay them the highest, fair, and reasonable wage that you can pay them to do that job.
Rule #3: Ensure that there is a proper paper trail, i.e., hire and pay your children using the same process you’d use for a typical employee.
Your child should have a job that they are capable of doing and actually do.
First, the IRS has caught on to folks who hire their children but do not assign them any work within the business. The solution is to assign them to tasks like administration and organization, shipping and fulfillment, working with computers or software, or simply cleaning. Remember to keep their hourly workload under eight hours per day.
Your child’s wage should be fair and reasonable.
For menial tasks, assume the minimum wage. Call local businesses and jump on an employment website to find out what people in your region are paid for the same job and associated responsibilities. Here’s a simple fix: Do you have a Human Resources (HR) employee? Ask them to take care of it. Of course, speaking to a tax professional or CPA firm is highly recommended.
Hire and pay your children the same as a typical employee.
Third, when you hire your children, take the same steps you would ordinarily take in the hiring process. Why? One thing the IRS will look for is a paper trail. That means you do not pay in cash, and you do not promise rewards, like a new car or college tuition, in exchange for work. You need to pay your children on time. The easiest way is to pay your children with checks or money transfers and to issue a pay stub whenever applicable. These transactions are highly visible and should provide ample documentation if you ever need to provide proof for the IRS.
Again, if you employ an HR professional, simply have them run your children through the standard process.
Can you pay your children as 1099 contractors?
Technically, yes, you can. But that does not make much sense because self-employment tax will be applied to your children’s wages, and that does not promote the kind of tax savings we’re looking for. In light of the three rules for compliance above, it makes sense for children to be on the payroll and paid as W2 employees.
What if business owners don’t follow the rules?
If the IRS suspects that you’re just employing children to reduce your tax bill, they will disallow the expense, and you’ll pay taxes plus penalty fees plus interest on the late tax. There may be an audit. It’s just not worth it.
Partner with a firm specializing in strategic planning.
If you’re considering hiring your children, you’re likely a business owner interested in taking full advantage of the tax code.
Hiring your children comes with a tax reduction, but the value of disconnected tax reduction tactics is fairly low. High-value, long-term tax savings come through deliberate, strategic, proactive planning: marshaling the combined force of deductions and credits, accounting practices, tax-efficient entity structure optimizations, and business advisory services to reduce liability and increase business performance.
that’s why I’ve built a team and network to make it happen for small business owners.
Schedule a discovery call today, and we’ll hit the ground running.
Talk soon,
Jeremy A. Johnson, CPA
References
- IRS. Topic No. 751 Social Security and Medicare Withholding Rates | Internal Revenue Service [Internet]. IRS.gov. 2024 [cited 2024 Dec 2]. Available from: https://www.irs.gov/taxtopics/tc751
- IRS. IRS Provides Tax Inflation Adjustments for Tax Year 2024 | Internal Revenue Service [Internet]. IRS.gov. 2023 [cited 2024 Dec 2]. Available from: https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2024
- U.S. Department of Labor. Child Labor Provisions of the Fair Labor Standards Act (FLSA) for Nonagricultural Occupations | U.S. Department of Labor [Internet]. DOI.gov. 2016 [cited 2024 Dec 1]. Available from: https://www.dol.gov/agencies/whd/fact-sheets/43-child-labor-non-agriculture