Running a small business offers many advantages, especially when it comes to structuring tax-saving strategies. One such strategy is the often-overlooked benefit of employing your children. Not only does it provide a valuable opportunity to teach your kids work ethics and business acumen, but it also has significant tax advantages for the family and the business. In this post, we'll explore the tax benefits of hiring your children and how this strategy can help reduce your overall tax liability.

1. The Basics of Employing Your Children

Under current tax laws, small business owners can hire their children to perform legitimate work for the business, just like any other employee. However, the key difference is that when the child works for their parents' business, both the business and the parents can capitalize on tax savings. Here's how:

• Wages paid to your child are deductible as a business expense. This lowers the business's taxable income, potentially reducing its overall tax liability.

• Your child's wages may be exempt from Social Security and Medicare taxes, depending on the structure of the business and the child's age. Specifically, if your child is under 18 and works for a sole proprietorship or a partnership where the parents are the only partners, wages are exempt from FICA taxes.

2. Tax-Free Income for Your Child

The IRS allows taxpayers to pay their children up to the standard deduction amount (for 2023, this was $13,850) without the child owing any federal income taxes. This means that the first $13,850 your child earns is tax-free. Effectively, by hiring your child, you can shift income from your higher tax bracket to your child's lower (or zero) tax bracket.

For example, if you hire your 14-year-old child to help with tasks such as filing, social media management, or even maintaining the company's website, you could pay them a reasonable wage for their work up to $13,850, and they won't have to pay federal income taxes on that income.

3. Business Benefits: Lower Payroll Tax Obligations

If your business is a sole proprietorship or a partnership where the only partners are the child's parents, the wages paid to a child under 18 are exempt from FICA (Social Security and Medicare) taxes. Additionally, if the child is under 21, the wages are exempt from FUTA (federal unemployment taxes). This exemption makes hiring your children especially advantageous, as it reduces the overall payroll tax burden for the business.

It is important to note that these exemptions do not apply if your business is a corporation, even if it's an S corporation.

4. Retirement Savings for Your Child

Paying your child through your business also creates an opportunity for them to start saving early for retirement. Because they are earning wages, they are eligible to contribute to a Roth IRA. As of 2023, your child can contribute up to $6,500 annually to a Roth IRA, provided they have earned at least that much income. Since the wages are likely tax-free, the earnings placed in the Roth IRA can grow tax-free, providing them with an excellent head start on long-term savings.

5. Educational Expenses and Family Needs

Another great benefit of this strategy is that wages earned by your child can be used to pay for personal expenses that you might already be covering, such as private school tuition, summer camps, or extracurricular activities. By hiring your child and having them earn their own money, you can essentially shift taxable income from yourself to them, reducing your overall tax burden, all while maintaining control over how that money is spent.

6. Important Considerations: Documentation and Compliance

While hiring your child can offer significant tax advantages, it is crucial to adhere to IRS guidelines to avoid potential issues:

• Legitimate Work: The work your child performs must be legitimate and appropriate for their age. For example, a 10-year-old could handle simple office tasks but would not reasonably be expected to manage complex bookkeeping.

• Reasonable Pay: Compensation must be reasonable for the work being performed. Paying your child $50 an hour to clean the office bathroom would likely raise red flags with the IRS. Always ensure the wages align with what you would pay a non-family employee for the same tasks.

• Record-Keeping: Proper documentation is essential. Keep detailed records of the hours worked, tasks completed, and wages paid. This will help substantiate the legitimacy of the arrangement in the event of an IRS audit.

7. Is This Strategy Right for You?

The strategy of hiring your children is particularly beneficial for small businesses structured as sole proprietorships or family partnerships. However, it is not suitable for every business or family. Corporations, including S corporations, do not enjoy the same FICA exemptions, and if your business doesn't have legitimate work for your child to perform, the IRS could challenge the arrangement. Before implementing this strategy, it's wise to consult with a tax advisor to ensure compliance with all applicable regulations and to maximize your tax savings.

Hiring your children as employees can be a powerful way to reduce your tax liability while teaching them valuable life skills and giving them a head start on financial independence. With proper planning and compliance, you can turn family employment into a significant tax-saving strategy for your business. As always, working closely with a legal or tax professional is recommended to ensure you are following all IRS guidelines and maximizing the available benefits.

If you're interested in learning more about how to structure your business for maximum tax efficiency, including hiring family members, contact us today to schedule a consultation.