Employing your child as a legit employee could reduce your taxable income. Seriously.
If you’re a business owner and a parent, hiring your child can have huge personal benefits. You get to spend more quality time together, you can help set them up for real-world success, and you know exactly how to track them down if they mess up on the job.
But what you might not know is that there can also be substantial tax benefits to hiring your children. In fact, if done right, you can prevent thousands of your dollars from going to the IRS. This is even more true after the passing of the Tax Cuts and Jobs Act, which eliminated the ability to take personal exemptions (e.g., your children) as deductions on an individual tax return.
Here are the tax benefits you can take advantage of if you employ your children as a small business owner.
- The businesses that can benefit from hiring their children
- The tax benefits of employing your child
- How to employ your kid—without getting in trouble
The businesses that can benefit from hiring their children
Not every type of business entity benefits from the owners hiring their children. Specifically, if you operate as a corporation or a partnership with someone other than your spouse, the only advantage you’ll really see is the ability to write off your kids’ salaries on your corporate tax return, just like you do with all your other employees.
Also, no matter what kind of business you own, if your child is 21 or over you can’t get any special tax benefits from employing them.
But hiring a child under 21 years old can be advantageous if you operate as:
- A sole proprietorship
- A spousal partnership
- An LLC that is treated like either of those for tax purposes
In other words, if you file taxes using the Form 1040, Schedule C, keep reading—because you can reap some major tax benefits.
The tax benefits of employing your child
Alright, now onto the good stuff. You can shelter yourself from paying most—if not all—taxes on the wages you’re paying your children if your business is either a 1) sole proprietorship, 2) a partnership where both partners are spouses, or 3) an LLC that has elected to be treated as either #1 or #2. The tax savings of hiring a child is probably the biggest advantage of running a family business. You can’t harangue your neighbor’s lazy teenager the same way you can your own kid, and you definitely can’t avoid your share of their SS, Medicare and FUTA tax.
Specifically, if you employ your child who is under 18 years old, their wages are exempt from:
- Social Security tax
- Medicare tax
- Federal unemployment (FUTA) tax
Once they turn 18, you’ll have to start paying Social Security and Medicare, but they remain exempt from FUTA tax until they turn 21.
Plus, you can still deduct their salaries as a business expense, thereby reducing your taxable income.
Better yet? Because of the new standard deduction, the first $12,400 your child makes is entirely exempt from taxes. How does that work? The standard deduction that the IRS gives taxpayers reduces taxable income dollar-for-dollar up to $12,400 for those filing single.
If you meet these requirements for hiring your child, neither of you will pay taxes on those salaries on either end:
- Under 18 years of age
- Part-time gig
- Paying them less than $1,000 a month
This will save you thousands over the course of the year. Even if your kid does cross that $12,400 threshold, their tax bracket is likely much lower than yours, which means it’s still reducing your family’s tax load.
How to employ your child—without getting in trouble
Of course, you can’t just tell the IRS your child is an employee and pay them a hefty sum in order to reduce your taxes. The IRS knows there is a huge benefit in doing this, so they often look more carefully when you have someone on your payroll with the same last name as you.
Luckily, there are ways to keep things legit. Here are a few guidelines to follow:
- Your child must be an actual employee doing necessary work for your business. No, they don’t have to be doing the most crucial tasks, but you also can’t give them a fake job just to pay them for it, or have them do personal chores in exchange for a salary.
- Your child must be seven or older to be a valuable employee. Your kid also has to be old enough to actually perform useful services for your business. Sorry, that means you can’t hire your newborn for the tax break. Generally, any kid under seven will be deemed too young. Be sure to check your state’s requirements for employment as they can vary quite a bit.
- Your child must be making a reasonable salary for the work they’re doing. In other words, you can’t hire your kid for an hour of letter stuffing and pay them a grand to get the tax-free benefits. Pay your child around the same amount that you’d pay any employee for the work they’re doing.
- You have to follow all the legal rules of employment:
- Onboard your kid just like any other employee.
- Get their Social Security number, and fill out Form W-4 and the Employment Eligibility Verification (Form I-9).
- Make sure you have an Employer Identification Number.
- File Form W-2 at the end of the year, reporting how much you paid them.
- If you’re paying them hourly, have them fill out timesheets for good measure.
Hey, you could probably use the extra hands anyways, so why not make the most of it?