The Tax Perks of Hiring Your Kids!
We are asked all the time about whether a business owner can hire a dependent child to work in their business. The answer is always an emphatic “Of course you can!”. After all, it’s your business, right? That said, there’s one cool strategy that we can employ that acts as the Triple Crown of tax savings…but It’s not for everybody…and not for every business.
“Triple Crown, you say? Tell me MORE!”
Hiring your kids to do meaningful work is something many business owners strive for. I have dreams of passing down my accounting biz to my kids. Thus far, I’ve got one breaking into the music scene, another going for a nursing degree, and one studying history. No takers…but hey, it’s worth a shot...I still have two more chances.
They all have worked to earn a little side money – doing real work for comparable pay to what they’d make elsewhere. It was a nice way to get them some extra cash and to get some projects done around here that I wouldn’t stop long enough to do myself. It’s a nice way to expose them to the business, and, hey, let’s face it, it’s a nice way to take some expenses and “keep it in the family”. In the tax world, they call it “income shifting.”…I call it…"lower my tax bill…legally.” Done correctly, this lowers the business owner’s taxable income and, of course, lowers the tax bill for either the owner or the business…or BOTH!
Pretty cool, huh? Well…that’s just one perspective – and the most straightforward. The “Triple Crown” I’m referring to is only available to business owners that are either an unincorporated sole proprietorship or partnership (where both parents are the only owners). This “angle” serves not only to reduce the business owner’s taxable income but adds on payroll tax savings as well as the dreaded Self-Employment tax savings. One caveat, as always…follow the rules properly. This article explores the potential benefits, IRS requirements, and risks of getting it wrong.
What is the Exception for Unincorporated Businesses?
Sole proprietors are not required to pay Social Security, Medicare, or FUTA taxes on wages paid to their children under age 18. This also applies to a child of any age who is disabled. As the business owner, you don't have to pay the employer portion of these taxes either. The exception also applies to partnerships BUT ONLY in the event that each partner is the parent of the child/employee. Third partner? Non-parental partner? No exception applies and Social Security, Medicare, and FUTA taxes are all in play. That said, they can still work for your business and still provide your business a tax deduction – just not the triple crown of not paying those payroll and self-employment taxes mentioned above.
The Potential Payroll Tax Savings:
Payroll taxes like Social Security, Medicare, and FUTA can amount to over 15% of wages. By not having to pay these on your kids's earnings, the savings really add up, especially for teens working full-time in summer. This puts thousands of extra dollars per child back in your pocket.
But Don't Assume It's a Free-for-All:
The IRS has strict criteria around employing relatives before these payroll tax exemptions can be claimed. In Ross v. Commissioner, providing pizza and entertainment to your children did not qualify as deductible wages.
The children must be bona fide employees, paid reasonable wages for work that is necessary for the business (at least minimum wage). Their duties, hours, and wages must be documented like any other employee. In Davis v. U.S., the owners lost these exemptions because their children did not perform “vital” services. So don’t expect tax relief for giving them fake jobs.
How to Qualify:
To qualify, your business must operate as a sole proprietorship or a partnership wholly owned by
immediate family members including parents, siblings, spouses, and children (natural or adopted). Payroll Tax exceptions do NOT apply for single-member LLCs taxed as sole proprietors (aka “disregarded entities).
If it appears the children may earn “too much” (more than the applicable standard deductions – to where income taxes would be due), make sure to withhold and pay income taxes. And of course, it’s worth noting, to pay attention to child labor laws!
Completing Form W-4:
Simply have your child write “EXEMPT” in Step 2. They do not have to indicate anything about the unincorporated status. $0 income tax and $0 payroll tax should be withheld.
You may need to provide your payroll provider documentation about your business structure and
relationship to ensure $0 taxes are withheld and paid on your children’s wages. Follow IRS Publication 15 (linked in the comments section of this article).
Final Thoughts:
Hiring your kids in your family enterprise isn’t just a lesson in responsibility; it can be a masterclass in tax savings. But, as with all things IRS, handle with care. Ensure genuine employment, pay fair wages, and don’t bend the rules. Consulting an expert and maintaining crystal-clear records will keep you in the clear. In the world of taxes, shortcuts can lead to long headaches. Stay diligent and play by the rules. And hey, if you don’t qualify for the "Triple Crown", at least getting one of the three isn’t all that bad!
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About Our Firm
Tim Thompson CPA PLLC is located in Dallas, Texas and is an expert in all areas of Texas taxes. We can help with individual or business taxes, tax resolution, tax preparation, and tax planning services.