A friend of mine recently told me that to enroll their kid in dance lessons, violin lessons, or swimming lessons, the price is $90/month. That can certainly add up! What if your business was structured in such a way that provided an opportunity for you to pay for those expenses with pre-taxed dollars?
Hiring your kids is a legitimate business deduction, given you pay them a reasonable wage and follow the guidelines laid out by the IRS. There are several pieces to make sure are in order before you begin, but the overall benefits make the to-do list well worth the extra effort! The IRS Court cases have approved hiring your children as young as 7 years old in the family business.
Employing your children is a great way to teach responsibility while including them in your family business. The money paid to the child can be used to save for retirement, higher education, or their own dance lessons. The employer gets a tax deduction for the wages and depending on the business structure the employer pays no payroll taxes on their child’s wages. The child can receive up to the standard deduction (12,550 in 2021) tax free without paying taxes on their earned income. The IRS is generous with their deduction, but there are specific steps to follow in order to take the deduction and withstand an IRS audit.
1. You must treat your kids as real employees. You will need to ensure a written employment agreement is in place and keep official timesheets that are signed by the employer (you, as the business owner). Timesheets must include the date, activities completed, and a timestamp.
2. Make sure the kids do real work and are paid a reasonable wage. The work your child does must be normal and necessary for the business. The child’s roles, responsibilities and wages in the company will all depend on their age and ability. For example, in a real estate investing company, a 16-year-old may be able to serve as a property manager: reviewing work order requests, picking up parts, driving to the rental to pick up checks, depositing checks to the bank, or answering phones. Depending on the skills, the 16 year old could run social media campaigns and run the credit reports of potential tenants. While a 7-year-old may not be able to do all of these tasks, they may be able to clean the properties or the business office, shred papers, alphabetize documents, or prepare mailings. When considering the wages for the child, a good question to ask is “what would I hire someone else to do the same work?” For example a social media marketer would command a higher wage than someone whose primary role is shredding and putting stamps on envelopes. My encouragement as you consider the types of work your kids can perform is to be creative, think outside the box, and document everything!
3. Make sure that you are paying your child as an employee, not an independent contractor.
4. Pay your children real wages (not pizza!), deposited into a bank account with their name on it. This account can be a joint account with both the parent and child’s name, to use the funds for expenses the kids need to pay anyway (like dance lessons or private schooling). Another option is to deposit the funds into a ROTH IRA or college 529 plan. You are allowed to pay by check or use a payroll processing firm to handle the paperwork. Regardless of how you do it, you must always keep a paper trail.
5. Comply with employment laws. If you have not done so already, you will need to file for an EIN. When they are first hired, make sure you have a form W-4 and form I-9 completed. At the end of the year/quarter, you will need to issue/file W-2s, Form 940, and Form 941. Please note: if you are a sole proprietorship or partnership where both parents are the partners, Social Security or Medicare taxes do not need to be filed, until the child reaches age 18. Being structured as a corporation or partnership with non-parent partners, would require Social Security and Medicare taxes to be paid. No unemployment taxes are due for the children regardless of the structure until the child reaches age 21.
6. Follow child labor laws. Child labor law outline when children can work, the allowed tasks, and what is allowed for their pay.
Hiring Children is just one of many strategies My Tax Coaching implements for proactive tax planning. If you would like to see how My Tax Coaching can assist you to reduce taxes and maximize the tax law, please contact us at www.mytaxcoaching.com/contact.