Hire Your Kids! The Truth

Tax Strategy: Hire Your Kids!

Deb Evans, Enrolled Agent

The Least You Need to Know:

• Yes, it’s real! Hiring your kids is a legitimate tax strategy. Unfortunately it has been grossly abused so it is on the IRS’ radar. Make sure you do it right, and you’ll be fine.

• The reason it is a good strategy for income-shifting is because the business owner can deduct the amount paid, AND the child will likely not owe any tax on the income. Why? The standard deduction for single filers for 2023 is $13,850. That means if a person earns less than that, they will not owe any tax. Further, when a parent hires a child under 18, they do not have to withhold social security or medicare taxes either. (If your business is an s-corp, then you do have to withhold social security and medicare taxes.)

• That’s why $13,850 is the “magic number” people talk about. This does NOT mean you can just pay your kid $13,850 and write it off. It MUST be a true employer/employee relationship.

• You will need to apply for an Employer ID Number with the IRS (EIN).

• Be sure you are hiring your child to do legitimate work that either you or another employee would be doing for your business.

• The pay for your child’s employment must leave your business bank account and go into an account with your child’s name on it. Your name can also be on it. As the parent, you can decide how much of that pay is available for your child to use, how much goes towards their expenses, and how much they need to be saving. 

• Tax law says that you must have a true employer-employee relationship with your child with a clear expectation of job requirements and appropriate pay. Write a job description with clear tasks. Choose a salary or hourly rate that you would pay someone else to do the job. Have an employment agreement with your child(ren).  Keep track of what your child does and how long it takes them. Be prepared to defend this if asked.

• If you hire your 7-year-old to empty the trash cans in your office, then you would need to pay him or her a rate that is commensurate with that task...not much. If you hire a teenager to design your website, then the rate could be considerably higher. Consider if you hired an outside contractor to do the job. What would you pay? Do not try to write off paying your four-year-old $13,850 for posing for your instagram pics. Those are the people the IRS will be picking off over the next year.

• You will need to pay your child through payroll. Do not issue your child a 1099. The rules for filing are different and they would be required to file and pay 15.3% self-employment tax.

• Roth IRA – anyone can contribute to a Roth IRA if they have earned income. You can open a Roth IRA for your child and contribute up to $6500 in it from the money your child earns. (The maximum is $6500 or 100% of the pay if less than that.) Just imagine how much that account will grow over the years – tax-free! If you use this strategy, be sure to issue your child a W2 at the end of the year to show that there was earned income to justify the contribution.

The longer version

Our country was founded and grew with family business. It was natural, at one point, for children to work with their parents for the benefit of the family business and the family. Even now, there are 5.5 million family businesses in the United States, according to the Family- Owned Business Institute (FOBI).

Children working in a family business learn marketable skills, develop a work ethic, gain responsibility, and bond with family by spending more time together. They gain confidence and experience that will help them when they seek their first jobs outside of your business. Additionally, children learn money management skills, contribute to paying for their own expenses such as extracurricular activities and sports, and even save for college or a first car.

As an entrepreneur and homeschooling parent, I included my children in many of my business activities. I financially supported my family as a professional photographer for over 20 years while raising my daughters. They and I have fond memories of going with me to photo shoots. They were wonderful at helping me capture natural expressions from children, resulting in better portraits. Our family gained many benefits from working together in my business.

Gaining tax benefits is just an added bonus!

The benefit to you:

• Tax Benefits

• Built-in Employees – The National Federation of Independent Businesses reported that 31% of business owners had jobs they couldn’t fill.

• Succession Planning – What are your plans for your business in the future when you retire? Over one-third of business owners in a recent survey state they wanted to transfer the business to a family member in the future. Hiring your child now is the first step down this road. My mom called me her “retirement plan” when I went to work with her in her tax practice several years ago. She has since retired and trusted me to take over the business.

Hiring kids is one of my favorite tax strategies for all the above reasons. It’s also the one most likely to be blatantly abused, which means the IRS will start cracking down on it, so be careful. Follow my instructions, though, and you won’t have to worry.

If your child does legitimate work for your business, you can pay him or her up to $13,850 (the standard deduction) in 2023 TAX FREE for both of you. Hiring your children to work in your business is a form of Income Shifting. You shift or move income from being taxable to you to being taxable to someone else in a lower tax bracket.

You can hire your children to do age-appropriate work for your business and pay them reasonable compensation for that work. Not only can you write off what you pay them as a business deduction, it is tax-free income to your child if the total pay is below the standard deduction for single taxpayers: $13,850 for 2023. They don’t even need to file a tax return. If their overall income is greater than that, the first $13,850 is tax-free and additional income up to another $11,000 is only taxed at the 10% tax rate.

In addition, a sole proprietor or LLC owner who hires their children is also exempt from having to withhold FICA (social security and medicare tax of 15.3%). If you’re a corporation or taxed as a corporation, you must withhold and pay social security and medicare taxes on the pay, even if they are exempt from federal tax withholding.

The important point is that it must be a legitimate, age-appropriate job paid an appropriate wage.

There are a lot of jobs that your child can do for your business from filing to cleaning to stuffing envelopes. Older children can handle social media or even design your website!

The Tax Courts have approved this deduction for children as young as 7.

• What chores are your children doing that could apply to your business (or already do!)?

• What services are you currently paying someone else to do that your child could do instead?

• What services have you wanted to outsource that your child could do?

• What tasks do you procrastinate to the point of avoidance? (Categorizing your expenses? Updating your mileage logs?) Your child might enjoy it, if only for the novelty of it.

Brainstorm some tasks that your child can do for your business. Remember, the rule for deducting business expenses is the expense must be ordinary and necessary for your business. So, the job your child does for you must involve ordinary and necessary work. Theirtasks don’t have to make or break your business, but they should be common and helpful. There is a list of suggested jobs and tasks in the Appendix.

If you have other employees, be conscious of “playing fair”.

To take this deduction, I recommend that you carefully document and keep a record everything your child is doing including the tasks and time spent. Remember, I recommend that you treat all deductions as if you will defend them in front of the IRS, even though the odds of you having to do so are low.

This deduction can be large, so it’s worth the extra effort.

Document how you came up with the pay for their services. It needs to be reasonable. What are the child’s capabilities and maturity? The IRS would never approve paying an 8-year-old $12,000 a year to empty the trash cans. What would you pay a total stranger to do the job?

For a younger child, you might pay minimum wage and track the hours your child spent. For an older child, the tasks can be more advanced, and you could pay by the project. You will still need to keep detailed records of the tasks performed.

Beyond tax savings, this is a great way to teach your child responsibility or a new skill. You could deduct a class for your teen to learn web design or beginner bookkeeping. You could help your children feel more a part of your business life.

Pay your child on a regular schedule as you would any employee.

How it Works

To be legitimate, the money must actually leave your business bank account and move into a bank account with your child’s name on it (your name can also be on it).

Beyond that, it’s not the IRS’ concern what you do with the money.

You will want to compensate your child, but depending on the age, you might not want to give them use of all the money that you’re deducting. You could use it to pay what you might pay an allowance. Use it to pay for your child’s sports or dance expenses. Let your children pay for those activities.

 My favorite strategy?

Use some of the money to fund a Roth IRA for your child. Any year that your child has earned income, he or she can contribute to an IRA. The Roth is the one that uses after-tax contributions (but there’s no tax in this case). The fund can grow tax-free. It can grow until your child is ready for college. Funds can be withdrawn penalty free for college expenses or to purchase a first home. Or they can remain in the fund until your child turns 59 1⁄2 and can withdraw them penalty and tax free. You could fund a 529 or Coverdell Education Savings Account.

If it’s reasonable, you can, of course, pay your child more than the standard deduction of $13,850; however, they will need to file a tax return at that point and pay any tax due at their tax rate (probably 10%).

 What about Child Labor Laws?

There’s no issue when you’re hiring your own children.

The U.S. Labor Department’ Fair Labor Standards Act

(FLSA) minimum age requirements do not apply to minors employed by their parents, or by a person acting as their guardian. An exception to this occurs in mining, manufacturing and occupations where the minimum age requirement of 18 years old applies. State laws often follow the same pattern as the Fair Labor Standards Act regarding minors working for their parents

According to Texas Labor Laws:

When a business is owned or operated by a parent or legal Custodian, the parent or custodian may employ their own children at any age to work any hours, so long as the work is non-hazardous (not prohibited) and the child works under the parent or custodian's direct supervision.

 Employment Laws

To audit-proof this deductible expense, follow all required employment laws. Even if your only employee is your child, all employers must have an Employer Identification Number (EIN) from the IRS. You can apply for an EIN on the IRS.gov website by completing the SS-4 online form. Have your child(ren) fill out Form W-4 and state W-4 forms if required in your state. Keep these forms on file in case you ever need documentation. Also, have your child fill out Form I-9, which verifies the identity and work eligibility of the employee. Yes, you can fill out the forms for your younger child.

W2? 1099?

Do NOT give your child a 1099. The rules for self-employment income (that a 1099 would indicate) are different and require a tax return to be filed with just $400 in net self-employment income.

There is mixed advice about whether you need to file a W2 in this circumstance. I do recommend issuing a W2, especially if you will be using the Roth strategy - you must show proof of earned income. I will be sharing info about the easiest way to do this in a future blog post.

The exception

If you are a corporation or a business partner with a non-parent, you will need to withhold federal taxes and FICA on your child’s behalf. In that case, you will need to file payroll reports and issue a W2 at the end of the year. The child would need to file a tax return and get a refund of federal taxes. If you are contributing to a Roth IRA for your child, then you should issue a W2.

Tax Note: A popular online trend is to advise small business owners to claim their child is modeling because they use the child’s images on their social media and marketing. I caution against this. If your child is truly a model working for other clients as well, or you’re paying a professional photographer to shoot an advertisement, go for it. If you are claiming to pay your child large modeling fees for iPhone pics you take at the park, I’d expect the IRS to throw those payments out. Be reasonable!

IRS SOURCE: Source: Publication 929, Tax Rules for Children and Dependents

 The Audit Risk

Thanks to TikTok influencers, this strategy has spread like wildfire and there’s been some horrible advice given. I had a client write me recently because her friend’s CPA had told her she could pay her kids from her business for doing their chores and then write it off. NO NO NO!!! Fortunately, she asked me. Because of the rampant abuse (paying your child $13,000 for “modeling” on your Instagram, for example), the IRS will be looking at this. IF you are audited - which simply means the IRS writes you a letter and says “prove it” - you will want to send them your job description, list of duties your child is performing, proof of payment, and anything else you can show that you’ve followed the guidelines I’ve given. If you can’t do that, then expect the IRS to toss the deduction and possibly charge you an underreporting penalty.

Job Ideas for Hiring Your Child in Your Business

Jobs should be age and skill appropriate with reasonable wages

·      Cleaning the office

·      Washing company cars

·      Updating customer lists in the computer

·      Simple to advanced Data-entry

·      Transcribing video or audio

·      Trips to the post office or general errands

·      Helping at the office, passing out handouts and more

·      Walking door to door, placing fliers for your business

·      Updating your social media accounts (kids are very good at this)

·      Act or model for TV, web, or print advertising

·      Answer customer emails

·      Answer the phones

·      Assist with office work

·      Assist with monitoring social media, including posting on

·      blogs, Twitter, Facebook, Instagram, YouTube, etc.

·      Assist with website maintenance and updates

·      Care for the plants in the office

·      Clean the office or building

·      Clean company vehicles

·      Collect rents or other business collections

·      Create or distribute marketing materials and brochures

·      Deliver supplies, parts, or orders

·      Draft correspondence

·      Edit videos

·      Host at company events

·      Landscape and yard work including mowing, weeding, or snow

·      shoveling

·      Maintain an email autoresponder for customers or prospects

·      Maintain the office building including light bulb replacement,

·      HVAC filter replacement, etc.

·      Make coffee, tea, or other snacks for office employees or

·      clients

·      Make small repairs to the office or building such as painting

·      Perform research on the Internet

·      Prepare client newsletters

·      Data Entry

·      Prepare/update spreadsheets for the company

·      Price shop supplies

·      Product testing and feedback

·      Provide bookkeeping and basic accounting assistance

·      Provide food prep, setup, decorations, cleanup, etc for

·      legitimate business dinners or parties

·      Purchase office supplies for the office

·      Purchase supplies for office events

·      Research competitors’ marketing efforts

·      Research for new product lines

·      Respond to social media

·      Review and monitor the business plan

·      Review invoices and bank statements

·      Run errands

·      Send appointment reminders to customers or prospects

·      Send birthday cards to clients/customers

·      Serve on the board of directors

·      Service equipment

·      Shred documents

·      Solicit and compile customer testimonials

·      Stock supplies

·      Take notes in meetings

·      Take photographs for your social media

·      Shoot videos

·      Transcribe audio files or dictations

·      Transcribe corporate minutes

·      Use their voice for radio advertising

·      Valet park for events

·      Wash the windows

·      Wash uniforms and towels

Read my book “Yes, But…Tax Savings Strategies for Solopreneurs” for more tax strategies that you can use!

The Fine Print

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction. IRS Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in the entries in this blog (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.