Employing your child

Many providers employ their own children under the age of 18 to help with their workload. If you employ and pay your child the right way it's deductible, which means you don’t pay payroll taxes on it. It’s more than just tax savings, too. You're shifting income from your business, which would normally be taxed at your business rate, to your child, who may pay little or no taxes. 

You're taking income taxed at your rate and having it be taxed at your child’s tax rate. Your child can claim the standard deduction on the pay, and you get a business reduction by removing taxable income from your business and giving it to your child, who doesn’t have to pay taxes on it (if the amount you pay them is at or below the standard deduction). As a bonus, if your business isn't taxed as a corporation (like a sole proprietorship) and your child is under 18, you don't have to pay FICA, Medicare, or federal unemployment taxes on their wages.  

It’s easy if your business is a sole proprietorship or single member LLC. It's more complicated for S Corporations. 

You need an Employer Identification Number (EIN), even if you’re a sole proprietor. If you don’t have an EIN, visit the Get an employer identification number webpage on the IRS website. Having an EIN helps protect your information when you need to give it out. You reduce the risk of identity theft by using an EIN instead of your Social Security Number.

Step 1: Prepare a job description that describes the responsibilities of your child’s job. Some examples include playing with children, cleaning up, preparing meals, cleaning toys, and basic record-keeping. Don't include personal activities such as shopping, mowing the lawn, running family errands, etc. Don't count activities that would still be done if you weren't in business. 

Step 2: Prepare a written agreement between you and your child that describes their job, schedule, hours, pay, etc. Both parties should sign this agreement. 

Step 3: Keep a record of when your child worked (Monday 9am - 10am, Tuesday 9am - 10am, Wednesday 9am - 10am, etc.).  

Step 4: Maintain proof of payment. If you pay your child in cash, have a system in place to log those payments, just like you would with any other receipt. Instead of cash, you could pay by ACH or check.  

Whichever method you choose to pay your child, make sure the wages are paid into an account in your child’s name. You can't transfer it into your personal account and claim you’re paying them. What you pay must be a reasonable wage for reasonable work. For example, you could not hire your child to do dishes or pay them $300 an hour to file paperwork. 

If you pay your child directly from an S Corporation, you must treat them like a regular employee by paying FICA and Federal Unemployment taxes. The good news is there’s still a way maximize your deductions. 

Step 1: Set up a separate sole proprietorship or single member LLC.  

Step 2: Have your S Corp contract with the new company you set up. This is so the new company you set up can pay your children.  

Example: You want to pay your child to file paperwork. Set up a sole proprietorship or LLC (these are sometimes called family management companies). We’ll call it XYZ Family Management Company. This company can now contract with your S Corp for file management services. Your S Corp pays XYZ Family Management and XYZ Family Management pay your your child. This moves your child’s payment into a company that isn't a corporation, so you don't have to withhold FICA and federal unemployment taxes.  

If you set up a family management company, make sure you have documentation. With our example, XYZ Family Management Company would send invoices to the S Corp, and the S Corp is sending 1099s to XYZ. 

Grandchildren, nieces, nephews, etc. work the same way, but the parent of the child being paid must be the one to set up the subcontractor company. 

Remember, you don’t have to pay taxes, so filling out a W2 is good for record-keeping. 

Your child’s W2 will look similar to the one below: 

The main idea is when you pay your child, the payment comes out of the business. This makes it a deduction because it's payroll, but then it goes to your child and if kept under the standard deduction for the year, you don’t pay taxes on it. 

A couple other things to keep in mind while you go through this process: 

1. You don't have to pay your child the federal minimum wage of $7.25 per hour. However, you should check with your state’s department of labor to see if you must pay any state minimum wage.
2. Check with your state to see if you must purchase workers' compensation insurance. 

Maximizing your deductions during tax season isn't the only way to benefit. The money can go into your child’s savings account but since they're employed, you could also put up to $6,000 a year in a Roth IRA. These funds will grow tax-free, and it creates an opportunity to build their future. It can be used for college, a home purchase, or even retirement.  

Another option is placing the wages in a 529 savings plan to help with future education (or current education if your child goes to a private school). A 529 savings plan allows you to save money for expenses related to education. The money contributed to a 529 savings plan is invested and continues to grow throughout the life of the investment. 

When you use a Roth IRA account or a 529 savings plan, the capital gains are tax free, meaning the money is always tax free from start to finish.  

Let’s review the steps you must take to properly employ your child: 

• Prepare a job description and set a reasonable pay rate.
• Document the work.
• Have a place to put the money (an account in your child’s name).
• Fill out a W2 at the end of the year and be sure to have an EIN.
• Do your child’s taxes. You can use a free version of common tax preparation software for your child’s taxes because they are under the standard deduction. 

Paying your children and deducting their wages as a business expense keeps them from paying taxes if they stay under the standard deduction. 

If you want to deduct the amounts you pay your children, you must follow the rules above.

Disclaimer 

The information contained here is for educational purposes only and is not intended to constitute legal, tax, or financial advice.