Tax Benefits of Hiring Your Kids and IRS Rules to Follow

Tax Benefits of Hiring Your Kids and IRS Rules to Follow

Hiring Your Child: A Fun and Tax-Saving Solution

Family Business

It’s that all-too-familiar scenario: the kids are complaining about having nothing to do, especially during the long summer months. But what if there was a way to keep them productive, teach them valuable skills, and potentially lower your tax bill at the same time? Enter the idea of hiring your child to work for your business. Not only does this provide tax benefits, but it also ensures that your children are engaged in meaningful work. However, before you jump in, it’s crucial to understand and follow the IRS rules.

Tax Benefits of Hiring Your Child

If you play by the IRS rules, hiring your child for your business can lead to several valuable tax benefits:

  • Lower taxable income: By deducting your child’s salaries from your business income, your taxable income can be reduced.
  • Exemption from certain taxes: If your child is below 18 and depending on your business type, you may not have to take Social Security and Medicare taxes from their pay.
  • Tax-free income for your child: If your child’s income for a specific tax year is lower than the standard deduction amount, they won’t have to pay taxes.
  • IRA contributions: Since your child will have earned income, you can contribute to an Individual Retirement Account (IRA) on their behalf, subject to applicable contribution limits.

IRS Rules for Hiring Your Child

To fully enjoy the tax benefits, you must adhere to the following IRS rules:

Real Work for Real Wages Make sure that the work your child performs is genuine and paid fairly. Your child must genuinely be working for your business. Avoid drawing IRS scrutiny by pretending that your child worked for you when they didn’t.

Appropriate and Legitimate Tasks Select tasks that are relevant and recognized in your industry to ensure their legitimacy. Activities like adding data to a spreadsheet or managing social media accounts can be helpful for your business, even if your child might consider them easy.

Age-Appropriate Work Consider your child’s skills and abilities when assigning tasks. If your child is skilled in a specific area, have them assist with related tasks. For example, if your child excels at math, they could review expense calculations. However, avoid assigning your child tasks outside their skill set, as it wouldn’t make sense from a tax perspective.

Reasonable Compensation Compensate your child fairly for the work they perform. Pay them a wage that aligns with what you would pay other workers in similar roles. If you’re unsure about fair wages, consult colleagues, staffing agencies, or salary comparison websites for guidance. However, avoid overpaying your child, as claiming an unrealistic wage could raise concerns with the IRS.

Different Tax Rules for Different Business Types

The applicable taxes when hiring your child may vary depending on your business type. Here’s a breakdown:

  • Sole Proprietorship or Partnership with Parents: If your child is under 21 when working for your business, their pay won’t be subject to Federal Unemployment Tax (FUTA).
  • Corporation, Partnership (not with parents), or Estate: Regardless of the child’s age, payments to your child are subject to income tax withholding, Social Security, Medicare, and FUTA taxes.

Follow Laws and Document Everything

As a parent who hires their child, you become an employer and must adhere to employment and labor laws. While children are generally permitted to work in businesses entirely owned by their parents, it’s essential to pay attention to federal and state child labor laws. Certain age restrictions and hazardous conditions limitations may apply.

From a tax standpoint, ensure that you accurately fill out necessary forms, such as the W-4, with proper Social Security numbers and Employer Identification Numbers (EINs). Issue a Form W-2 to document your child’s pay, and keep detailed records of their work hours, including dates and task descriptions.

If your child is over 18 and you treat them as an independent contractor, establish a signed contract outlining their responsibilities and issue a 1099-NEC as required by the IRS.

If you find yourself unsure about IRS requirements or the specifics of hiring your child to work for your business, consult a trusted finance or tax professional who can provide guidance tailored to your situation.

Empower your children, save on taxes, and make the most of their summer by giving them real responsibilities within your business. It’s a win-win scenario that fosters growth, learning, and financial benefits all at once.