As summer approaches, you might be considering hiring your child at your small business. You may also have kids who want to earn more spending money. By putting your child on the payroll, you can reduce your family’s income and payroll taxes. Win-win situation! Here are four tax advantages.
Shifting business earnings when hiring your child
You can shift some of your highly taxed income into income that is tax-free or subject to minimal taxes by paying wages to a child as compensation for services performed. The child’s job must be legitimate and their pay must be reasonable for your business to be allowed to deduct the wages as a business expenditure.
Consider this scenario: you are a sole proprietor paying taxes at a 37% rate. You hire your child, your 16-year-old son, full-time in the summer and part-time in the fall to assist with office duties. He has no other sources of income, and makes $10,000 a year. Your son can use his $13,850 standard deduction for 2023 to shelter his earnings, saving you $3,700 (37% of $10,000) in income taxes.
Even if your son’s earnings are greater than his standard deduction, family taxes are reduced. This is due to the fact that, rather than being taxed at your higher rate, the unsheltered earnings will be taxable to him starting at a 10% rate.
READ MORE: 18 Tax Deductions for Small Businesses
Income tax withholding
Federal income taxes will probably need to be deducted from your child’s pay. An employee can typically claim exempt status if they had no federal income tax liability for the previous year and don’t anticipate having any this year.
However, exemption from withholding can’t be claimed if: 1) the employee’s income exceeds $1,250 for 2023 (and includes more than $400 of unearned income), and 2) the employee can be claimed as a dependent on someone else’s return.
Remember that when filing a return for the year, your child will likely receive a refund for all or a portion of the withheld tax.
Social Security tax savings
By giving some of your earnings to your child, you can also reduce your Social Security tax if your business isn’t incorporated. This is due to the fact that services rendered by a child under the age of 18 when they are working for a parent are not considered as employment for FICA tax purposes.
Earnings paid to a child under the age of 21 who is employed by a parent are exempt from FUTA (unemployment tax), which has a comparable but more liberal exemption. If hiring your child for a job in a partnership made up entirely of his or her parents, that partnership is likewise exempt from FICA and FUTA requirements.
Note: There’s no FICA or FUTA exemption for hiring your child if your business is incorporated or is a partnership that includes non-parent partners. However, there’s no extra cost to your business if you’re paying a child for work you’d pay someone else to do.
Your business also may be able to provide your child with retirement savings, depending on your plan and how it defines qualifying employees. For example, if you have a SEP plan, a contribution can be made for the child up to 25% of his or her earnings (not to exceed $58,000 for 2021).
Depending on your plan and how it identifies qualified employees, your company may also be able to contribute to your child’s retirement savings. For instance, if you have a SEP plan, you can contribute for the child up to 25% of their income (no more than $66,000 in 2023).
Contact us if you have any questions about hiring your child or the rules in your situation. Keep in mind that some of the rules about employing children may change from year to year and may require your income-shifting strategies to change too.
Originally posted April 2021. Updated April 2023.