Hiring Your Children Part I: The Basics

While there are many tax-smart ways to transfer money to your children, we often get questions from landlords and business owners on the tax benefits of paying their children through their business.

That’s why this week, we’ll discuss the ins and outs of paying your children through your business including the tax benefits and common formalities related to hiring them. 

Let’s get started!

Is it Legal to Hire Children?

First things first, is it even legal to hire your children to work in your business?

Yes, under the Fair Labor Standards Act (FLSA), children under the age of 18 are not subject to a minimum age requirement or a limit on the number of hours they can work if they are hired by their parent(s) or other legal guardians. 

However, there is one stipulation here that needs to be addressed…

Although it’s legal to hire children under the age of 18, a frequently cited U.S. Tax Court case (Eller v. Comm’r, 77 T.C. 934 (1981)) provides guidance around the age the authorities believe is appropriate for children to perform meaningful services within a business.

In this case, the taxpayers paid their three children, ages 7, 11, and 12, for assisting with ground maintenance and cleanup of a mobile home park. The Tax Court allowed the payments to the 11 and 12-year-old but disallowed a portion of the 7-year-old’s payments and cited that “experience shows that 11- and 12-year-old children can generally handle greater responsibility and perform greater services than 7-year-old children.”

That said, while you’ll have to evaluate the skill set of each child you consider hiring in your business, typical roles we see our clients hire their children for include:

• Office cleaning 
• Mailing letters 
• Online research and data entry
• Shredding and organizing documents 
• Social media and website management 
• Landscaping and property maintenance

What Are the Tax Benefits?

Assuming you pay your child under the standard deduction ($12,950 for 2022) and they don’t have unearned income over $1,100 from investments, the child will generally not need to file a tax return. 

They will also be exempt from social security and Medicare (FICA) taxes as long as you employ them under a sole proprietorship or partnership wherein each partner is a parent of the child. Also, children under the age of 21 are also not subject to unemployment taxes (FUTA).

Thus they will generally not have to pay taxes on the wages you pay them, and at the same time, your business receives a tax deduction for the wages you pay them. 

If you’re in the 24% tax bracket this means you can save up to $3,108 in federal taxes by paying your child. If you’re in the 37% tax bracket, that’s $4,791.50 in federal tax savings.

Definitely a tax-smart way to shift income to your children!

Hiring & Paying Your Child

Even though you’re hiring your child, you’re still an employer and there are some formalities you’ll need to follow to ensure you don’t run afoul of any laws or regulations that could cause you to lose your deduction, incur penalties, or other headaches. 

When you hire a child, they must be an employee – you can only pay your children for business-related services, not personal services. They must be hired by your business and on the payroll just like a regular W-2 employee.

As an employer, you must comply with legal requirements for employers – this means you will need to fill out a Form W-4 and Form I-9. Additionally, state requirements will need to be determined for Unemployment Insurance and Workers Compensation exposure.

You’ll also want to draft a job description that describes the child’s work and keep it on file for your records. If you’re paying your child by the hour, keep a time log of the hours they work in your business.

When it comes to compensation, it must be reasonable – children generally have few skills, and their pay should reflect that. Their pay must also be reasonable per the task they are performing. Paying a child $30 per hour to clean the business office space wouldn’t make sense. For this reason, it generally makes sense to pay your child the minimum wage.

The Bottom Line

It is perfectly legal to hire your child in your business as long as you treat them like an employee and follow the formalities you would for other employees. 

If they are under 18 and receive income under the standard deduction, the income they earn will generally be tax-free. In addition, you’ll receive a deduction for the wages you pay them through your business. 

Lastly, they must perform meaningful work with your business and receive reasonable compensation for the tasks they perform. 

We’ll follow up next week with Part II where we’ll discuss a strategy on how you can use the money you pay your child to save for their future. And in Part III, we’ll discuss some of the more advanced topics around paying your children.