If you have kids under age 18 and a business, then you have a huge opportunity to save on taxes.
And that is by hiring them in your business and placing them on the payroll.
That’s right, hiring little billy and sally as employees in your business will not only save you on taxes…
…but the money you pay them can go directly to child expenses like clothes, school supplies, college savings, and much much more.
And we mean why not involve your kids in your business, show them the ropes, and teach entrepreneurship?
All while saving thousands of dollars on taxes.
We actually recommend this a lot to our clients as a strategy when they work with our tax planning services.
But there are rules and a proper way to do it.
And we’re going to break down everything you need to know in order to accomplish this.
Today, we’re excited to show you how to hire your kids and put them on the payroll.
By the end of this post, you will understand why hiring your children will save you thousands of dollars in taxes.
As well as how your kids can avoid paying tax on their income and the rules you need to abide by to hire your kids.
Benefits You’ll Get When You Hire Your Kids
So why is hiring your children a beneficial tax strategy for you and your kids?
You get a tax write-off for the pay you give them and in turn, your kids (or you) can use that income tax-free to help provide for what they need.
However, it is only tax-free if you pay them under the standard deduction.
So for 2020, that is $12,400.
And what makes this a very important number is that when you hire your kids, if you pay them $12,400 or less, they are not required to file or pay taxes on their income!
Do you understand now why this is such a valuable tax strategy?
Because we all know kids cost money.
Stop paying taxes then pay your kids. It makes very little sense to do this.
Instead, pay your kids and stop paying the tax on it. Got it?
S and C-corp Strategy to Hiring Kids
So let’s say you’re sole proprietor or LLC, your business is also not required to pay payroll taxes on the income you pay to your child!
In case you didn’t know, almost everything employer must pay social security and medicare taxes or “FICA” for each employee they have on payroll.
But since you are paying your child as an employee, this is actually not required.
According to the IRS:
“Payments for the services of a child under age 18 who works for his or her parent in a trade or business are not subject to social security and Medicare taxes if the trade or business is a sole proprietorship or a partnership in which each partner is a parent of the child.”
So it doesn’t cost you any additional money to hire your kids. Only the pay you give them which you were going to spend on them anyway.
And speaking of sole proprietors, if you want to learn how to pay yourself as a sole proprietor, then check out this post next.
Family Management Company Strategy
Now, the rules are a little different if you are an S-Corp or C-corp. Because if you pay your kids from an S or Corp, you would be obligated to pay social security and medicare.
But there is a workaround.
And that is by establishing a Family Management Company or FMC. This will act as the middle man between your S or C-corp and your child.
A family management company is simply a separate business that is either a sole proprietorship, LLC, or partnership that is owned by the parent or parents.
And what you would do is have the S or C Corp pay the family management company a ‘management fee’ for services.
Then the family management company would pay your child to perform those services.
So your kids would need to be on the family management company’s payroll and get paid from the FMC so you can avoid the employer payroll tax expense. Does that make sense?
If you want to know the tax differences between sole proprietor vs. LLC vs. S-Corp, then we also have a post for that.
Rules and Steps to Hire Your Kids
So you now understand the benefits of hiring your kids, let’s talk some details on how all of this works.
1. The first thing to remember when hiring your kids is making sure you have actual work for them to do.
Now this “work” doesn’t have to be technical or complex work.
It can be as simple as addressing envelopes, janitorial tasks, answering the phones, or helping with your website.
Whatever it is, their work should be ordinary and necessary for your business.
It can’t be personal services like making the bed or washing the dishes, alright?
2. You also want to make sure that the work is age-appropriate.
It is highly unlikely that a 6-year-old can find real estate deals for your investment company or braid hair in your hair salon.
It is also unlikely that a 3-year-old can do anything at all.
So with this in mind, your kids will have to be old enough to actually do some business-related tasks in your company.
Again, it doesn’t have to be complicated but it does have to be within your child’s capabilities.
3. So once you know what they will do, it’s important to keep track of the work and hours they perform.
The IRS always wants you to document everything and this is no different.
Make sure to use something like a timesheet to keep track of the days, duties they performed, and the hours they worked.
You may even want them to sign an employment contract the outlines their job role and pay.
This is not legally required, but will help you to justify their employment in your business.
4. The next thing to keep in mind is their pay.
Your kids’ pay should be for services they actually performed and should be reasonable.
Now when doing this strategy, it is most advantageous to pay your kids as much as possible.
This is so you can take bigger business tax deductions and shift some of your income to your kids who are probably in a much lower tax bracket.
However, you can’t just pay them any amount. It has to be comparable to what others make doing the same job.
For example, you can’t pay your kids $100 per hour to clean the office when other office cleaners in your area are making $15 per hour.
So first, find out what workers doing the same duties are being paid.
You shouldn’t have a problem as long as you’re paying your kids no more than what you would pay a stranger to do the same thing.
With that, make sure you pay them using a method that has a paper trail. So don’t pay them with cash since that is harder to keep track of.
Instead, pay them by check or direct deposit. Their pay should be made out to their name and deposited in an account with their name on it.
But get this, the account can be a 529 college savings account, Roth IRA, or a custodial account that you can control until your child turns 21.
So you can literally help them save for college or invest or even cover their routine costs all tax-free.
Because as long as their pay is not over the standard deduction, they will not have to pay taxes on the income you pay them.
5. As an employer, you still have to comply with some legal requirements as you would if you hired a complete stranger.
So you still need to fill out a W-4 and I9 for your child. Your child should have a social security number but if they don’t, they would need to apply for one.
Also, if your business does not have an EIN or employer identification number, you would need to apply for a free one on IRS.gov.
Now to help you save more on your business taxes, go ahead and talk to one of our CPA tax experts.