As a business owner, you’re always looking for ways to reduce your tax burden while building wealth. One effective and often underutilized strategy is hiring your children to work in your business. This approach not only allows you to shift income to a lower tax bracket but also provides an opportunity to teach your children about work ethic and financial responsibility. Below, we’ll explain what the hiring your child tax strategy is, outline the rules and stipulations, and highlight how it can benefit both your business and your family.

What Is the Hiring Your Child Tax Strategy?

The hiring your child tax strategy involves employing your children in your business and paying them a reasonable wage for legitimate work they perform. The wages are deductible as a business expense, reducing your taxable income. Additionally, if your child is under 18, their earnings are not subject to Social Security or Medicare taxes, and if they are under 21, they are exempt from federal unemployment taxes.

Rules and Stipulations

To take full advantage of this strategy while remaining compliant with IRS regulations, you must adhere to the following rules:

1. Legitimate Work:
   The work your child performs must be necessary and reasonable for your business. Examples include administrative tasks, cleaning, marketing assistance, or managing social media accounts.
2. Reasonable Compensation:
   The wages you pay must reflect what you would pay someone else for the same work. Overpaying your child could raise red flags with the IRS.
3. Documentation:
   

   Treat your child as you would any other employee:

   • Create a written job description for their role.
   • Track hours worked and tasks performed.
   • Issue a W-2 at the end of the year.
4. Tax Considerations:
   
   • Under Age 18: Wages are exempt from Social Security and Medicare taxes.
   • Under Age 21: Wages are exempt from federal unemployment taxes.
   • Income under the **standard deduction** ($14,600 for 2024 for single filers) is typically tax-free for the child.
5. Business Structure:
   This strategy works best for unincorporated businesses, such as sole proprietorships or partnerships where both partners are parents. If your business is incorporated, the wages may still be deductible but will be subject to payroll taxes.

How the Strategy Works in Practice

Here’s an example of how hiring your child can benefit your business and family:

• You own a small consulting firm and hire your 16-year-old to manage your social media accounts for 10 hours per week at $15 per hour. Over the course of a year, you pay them $7,800.
• The wages are deductible for your business, reducing your taxable income.
• Your child uses the earnings to fund personal expenses, contribute to a Roth IRA, building tax-free retirement savings, or contribute to a 529 college savings plan.
• Because their income is below the standard deduction, they owe no federal income tax.

Additional Benefits

1. Teaching Financial Responsibility: Paying your child provides an opportunity to teach them about budgeting, saving, and investing. Encouraging them to allocate part of their earnings toward long-term goals fosters financial discipline.
2. Building Skills: Working in the family business helps your child develop valuable skills, whether it’s customer service, marketing, or financial management. These experiences can benefit them in future endeavors.
3. Reinvesting in Your Business: The savings from reduced taxable income can be reinvested into your business, whether for expansion, equipment, or other growth initiatives.

Key Considerations

• Fairness and Compliance: The IRS scrutinizes businesses that employ family members. Ensure all payments are documented and legitimate to avoid potential audits. Documentation for legitimacy is important, including time sheets, paystubs, and actual services rendered.
• State and Local Taxes: Some states may have additional payroll tax requirements, even for children. If your business is incorporated, you will need to issue a W2 for the child as an employee of the company, which requires FICA deductions. Check with a tax professional to ensure compliance.
• Avoiding Misclassification: Do not classify personal expenses (e.g., allowances) as business wages. All payments must be tied to actual work performed.

Steps to Implement the Strategy

1. Define the Role: Identify tasks your child can perform that add value to your business.
2. Set a Fair Wage: Determine a reasonable hourly rate or salary for the work.
3. Document Everything: Create a formal employment agreement, track hours, and keep records of payments.
4. Issue a W-2: At the end of the year, provide your child with a W-2 and file the necessary payroll tax forms.
5. Consult a Professional: Work with a financial planner or tax advisor to ensure you’re meeting all IRS requirements and maximizing the strategy’s benefits.

Note: This blog post is for informational purposes only and should not be considered tax or legal advice. Always consult a qualified tax professional for guidance specific to your situation.