Should Your Children Be On Your Payroll?
By Trent Derrick, CMT
Hiring your children to work in your business has many advantages. You will get to spend more time with them and help them prepare for their future by teaching them real-life skills. And, as you have probably already heard, it could help you mitigate your tax burden because their income can be tax-free.
And why is this a good idea? By employing your child or children, you can divert income from your higher tax bracket to their lower or nonexistent tax bracket. This income diversion allows you to further reduce your taxes using a deduction for the salary or wages paid to your child or children. (1) Obviously, the more children you have working in your business, the more money you can save on taxes.
Below we discuss some points to consider before hiring your child to help out with your business.
1. What Job Can Your Child Do Well?
If you are a doctor and need an employee to handle complex billing coding and to engage with medical insurance companies, chances are your 16-year-old high school student won’t have the patience or aptitude to handle such a position. However, if you need someone to answer phones, interface with patients at the front desk, and do light filing as an office assistant, your teenager could probably help with this.
Remember to ask your child if this is something that they want to do. Maybe they have been asking for extra spending cash or maybe they want to save up for a senior trip or buy themselves a car. A part-time job answering phones in your office could help them meet their goals while teaching them work skills and financial responsibility. But if this is something they don’t want to do, coercing them into it probably will be bad for your business, your familial relationship, and your mental health.
2. Different Businesses, Different Rules
Your child can work for you tax-free up to $12,000 if your business is a sole proprietorship, a single-member LLC, or an LLC taxed as a partnership and owned by you and your spouse. However, if your business is an S or C corporation, you must pay payroll taxes on your child’s wages. (2) All structures must complete payroll reporting for a W-2 as well.
There are certain strategies you can use to avoid payroll tax on your child’s salary if your business is classified as a corporation. By using a family management company owned by you and your spouse that supports the corporation and pays your child or children their wages, you will not have to pay taxes on your child’s salary. The family management company would charge the corporation a management fee for its services to the corporation. (3)
3. Labor Laws
Hiring your children to help with your business has many advantages: it can potentially save you thousands of dollars in taxes, teach your children valuable life skills, and allow you to build a library of positive memories together. However, you must follow both state and federal labor laws to make sure the employment is legitimate.
Child Labor Laws
It’s also a good idea to familiarize yourself with federal and state child labor laws. For example, your child is prohibited from working excessive hours if they are under 18 years old. Also, child labor laws prohibit children from doing hazardous work. Perhaps you run a construction company; allowing your child to operate some heavy machinery is probably not legal. (4)
Real Wages, Real Work
Your child has to be completing real work for your company and benefiting from real wages, not college tuition or other education-related fees. Your child can use their own salary to pay for their tuition, but you cannot use the company to pay for your child’s tuition to get a business deduction.
Real work refers to any task related to the business. You cannot pay your child a wage if they are not actually working for the business or if they are conducting personal errands for you. They must be actively doing work that is related to the business. (5)
We Can Help
Hiring your child can result in a mutually beneficial situation, but it needs to be treated carefully to preserve the familial relationship and working environment, and to enjoy the tax-free status. Additionally, you should be aware of the rules and guidelines surrounding such employment. As always, each tax situation is unique, and this should not be considered specific advice. For help tailored specifically to you, consult your tax professional or my CPA network.If you are considering hiring your child, be sure to book a consultation with me here or email me at firstname.lastname@example.org.
About TrentTrent Derrick is a Financial Advisor and Chief Market Technician at Legacy Wealth Management. Trent is passionate about the value small businesses bring to their communities and specializes in serving small business owners by providing seamless financial advisory services tailored to their financial needs, including tax planning, cash flow management, retirement planning, and bookkeeping. Trent has a bachelor’s degree from the College of Charleston and studied economics at the University of South Carolina, Columbia. He is a Chartered Market Technician® (CMT). Trent serves as a guest lecturer for the College of Charleston’s MBA program and acts as chairman of the Market Technician Association’s Charleston chapter. When he’s not working, Trent, a proud Eagle Scout, enjoys volunteering with the Charleston Animal Shelter’s outreach program. Trent and his wife love to cook international cuisines and host dinner parties with their friends. To learn more about Trent, connect with him on LinkedIn.