Let’s face it, being a parent is challenging even in the best of times. So, business owners with kids basically have two full-time jobs (and our boundless respect).
However, if your kids are old enough, they may help you lighten the load by taking some business tasks off your plate. In return, Uncle Sam dishes out some favorable tax benefits. You already spend a lot of time with them, so what could go wrong with letting them work in the business?
Rhetorical question, I know, but let’s consider what could go right.
From a financial perspective, hiring your child(ren) is advantageous for two main reasons.
-
- First, any compensation under $12,550 can be fully deducted from business revenue and lower the taxable income on the business side.
- Second, if they’re paid under $12,550 and the standard deduction is $12,550, they would not owe taxes on the money they’ve earned.
Pretty sweet deal, right? Let’s break down how it works.
First off, you can’t say your newborn is the CFO or the head of operations for the business…but there are many legitimate options on the table. If your kids are between the ages of 7 and 21, you can hire them within the business to perform legitimate tasks and receive favorable tax benefits. They might file paperwork, fill orders, wash business cars, model a new product, or step in to be the business’s social media manager (especially since they are on the phone all the time anyways). Younger kids can work as a model for your advertising. As long as it’s an age-appropriate role, the Department of Labor won’t come knocking on your door.
Age is also an important factor in how much money you can save on taxes. If your kids are under 18, their compensation is typically exempt from Social Security tax, Medicare tax, and federal unemployment tax. This provides you with the biggest tax savings.
If they’re over 18, their compensation is only exempt from federal unemployment tax; Social Security and Medicare must be paid.
An important side note: Age is not the only factor; your entity structure matters, too. Read on for details.
Hiring Your Kids: What’s Your Entity Structure?
If your business files taxes using Form 1040, Schedule C (such as sole proprietorships or spousal partnerships), you’re typically able to get the full tax benefits of hiring your kids as long as all requirements are met.
Other entities (such as S Corps and C Corps) can deduct compensation from business expenses, but they are generally not exempt from payroll taxes, Social Security, or Medicare…unless you want to get a little creative.
For S Corps, C Corps, and non-spousal partnerships, instead of paying the child directly through the business, it’s possible to pay them out of a family management company.
Here is how it might work.
You would begin by forming a new business entity (typically a sole proprietorship) owned by you and/or your spouse. The only purpose of this new entity is to support the operations of your main company. Your kids are employed through the family management company, that company charges your business for the work done, and the kids receive tax-advantaged compensation. And since the family management company is owned by one or two parents, it falls under the IRS exemption — so no need to withhold payroll taxes, as long as the kid or kids are under 18 years old. This strategy must be done carefully and in accordance with laws and regulations in place, or the IRS may begin to question the need for that second business.
Hiring Children in the Family Business
Advantages:
-
- Can deduct compensation from business income as a business expense
- If child is under 18, no FICA withholdings or payments are necessary as long as requirements are met. Specifically, your business must be a sole proprietorship, a spousal partnership, or the child must be employed by a family management company.
Caution:
-
- Children must be legitimate employees
- Salary/compensation must be reasonable
- Must comply with legal employment requirements
- Not every situation is exempted from paying payroll taxes
Savings Range:
Your Tax Rate x $12,550 x Number of Children Employed
The Wrap Up
Hiring your children to perform business tasks can be a win for all parties involved. You get to spend some quality time together. They can learn a little about business and make some money. The parents get to teach the kids about the importance of good financial habits. And, if the arrangement is set up in a tax-smart way, everyone gets tax benefits. For business owners with kids, it can feel like a no-brainer.
When using this strategy, don’t forget to keep detailed records of hours worked and work performed, especially if you are paying them hourly (no different from how you would do it for an employee who is not related to you). Also, remember that their role must consist of legitimate tasks for the business. By following the rules that the IRS has laid out, this strategy can provide unique benefits for the family — and for the business.
If you want help determining how to approach this strategy or need a second set of eyes to review the strategy to ensure that all documents are completed and filed properly and the employment is compliant, reach out to our team at TreMonte.
Photo by maitree rimthong from Pexels