Have you ever found yourself asking yourself “will hiring children in business really save me on taxes?”
Many family owned businesses have heard that you can employ your minor children in your business and that there are tax benefits to this. The “what” of those tax benefits is often the part that confuses small service based businesses. So much so that they often don’t go this route because they really just aren’t sure how to make sure they are doing it right.
When you employ your children to work in your business,you need to make sure that you comply with both the IRS and the Department of Labor laws. Employing minor children can be an audit risk simply because so many people do it incorrectly. By maintaining the right records and following the rules, you can benefit from a huge tax savings. And all the while the money is still benefiting your family directly.
Labor Laws around hiring children
The Fair Labor Standards Act provides for certain exemptions. Youth younger than 16 years of age working in non agricultural employment in a business solely owned by their parents or by persons standing in place of their parents, may work any time of day and for any number of hours. However, parents are prohibited from employing their child in manufacturing or mining or in any of the occupations declared hazardous by the Secretary of Labor.
Tax Law around hiring children
The tax law has no minimum age. Tax court has even set the standard in one court case where the hiring of a seven-year-old child in the parents business was allowed.
The IRS website even states directly on it that “one of the benefits of owning your own business is the ability to hire family members to work in your business”. This can include spouses, children, parents, siblings, etc. But we are going to focus on the aspect of hiring your minor children in this article.
What you need to know
Because of the already heightened audit risk that comes with hiring children in business, it is important to know the rules and establish clear record keeping for your minor child’s employment.
This strategy works best if you operate your business as a sole proprietorship, a spousal partnership or a single member LLC. In many states you can often save on unemployment and FICA taxes also. This can add up to a decent savings for a high revenue business.
What about when you can’t bypass FICA taxes?
If you operate your business as an S or C Corporation, the rules are a little different. You can still hire your minor child in your business with some differences. Their wages will be subject to unemployment and FICA taxes similar to any other employee. This means the savings are not as beneficial, but they still come with the benefit of money to your kid as a business deduction.
In order to legitimately hire your minor child they have to perform actual work in your business. Work that is also age-appropriate is a key factor. You cannot hire your 7-year old child to do your customer service outreach for you. Your 16 year old child could very well do this. Your nine-year old kid could not run errands and pick up supplies for you. They could file and shred papers as well as clean the office.
You need proof that the amount you are paying your child is for the services actually rendered. Therefore, make sure that you have your child complete a weekly time sheet. This should disclose the date, description of work performed, and number of hours worked.
Another requirement is that you need to pay them a reasonable wage for the services performed. What is a reasonable wage? Well take a look at what you would pay someone else. If you pay an office assistant to file, shred and clean a rate of $13/ hour that is reasonable. You cannot pay your child $20/ hour for the same tasks. You also cannot only pay your child $7/ hour for the same tasks. Unreasonable wages will be targeted in an audit for the pay to a minor child so you want to ensure you are following this rule closely.
How do you maximize this benefit for your business?
The structure (business entity type) is going to play a key factor into what you do or do not need to do in regards to tax withholding. However, the key to tax planning really comes in looking at how you are structured. Looking at what point, if at all, does it make sense to adjust the way you operate to maximize this benefit of hiring children in business while your kids are still young.
Minor children, under the age of 18, can earn up to $12,400 (at the time of this writing) tax free income. If you own a business structured in one of the ways that allows you to not withhold some taxes, that this is essentially tax free money to your child and your family. The bonus is that it is a tax write off for your business. That almost seems like a double savings doesn’t it? In a sense it is…
Imagine all the things your child could do with that amount of money each year.
- Save for a car
- Pay for some of their wants
- Pay for some of their higher cost extracurricular activities
- This earned income could allow them to contribute to their own ROTH IRA and start building a retirement account from a young age
- Plus so much more
So let’s look at the reality of this situation.
You are now employing your child for actual age-appropriate work they do in your business and paying them. So instead of just handing them money when they ask for it, they are earning it and it is a write off for your business. Win-win!
Oh and you are teaching them financial responsibility in the process and they won’t even realize it until they are older so they can’t be mad at you for it now.
It’s legal to hire your children to work in your office. And such office work likely avoids any hazardous activity that would violate the labor laws.
Paying a reasonable amount for the work performed complies with the IRS rules.