What every family business needs to know about Hiring kids

Running a family business offers unique opportunities to involve your children in your entrepreneurial journey while creating significant tax advantages. Hiring your children as legitimate employees is one of the most potent yet underutilized strategies. This approach provides valuable work experience for your kids and can generate substantial tax savings for your business through wage deductions and payroll tax exemptions.

Understanding the Hiring kids strategy

The Hiring kids strategy allows family business owners to shift taxable income from higher tax brackets to their children's lower tax brackets while creating legitimate business deductions. When appropriately structured, wages paid to children can be entirely tax-free for the child (up to the standard deduction amount) while providing the business with valuable payroll deductions.

Key benefits of hiring your children

This strategy offers several compelling advantages for qualifying family businesses:

• Immediate business deductions: Wages paid to your children create immediate business deductions, reducing your taxable income dollar-for-dollar
• Payroll tax exemptions: Children under 18 are exempt from Social Security and Medicare taxes when working for their parents' sole proprietorship or spousal partnership
• FUTA tax savings: Children under 21 are exempt from the Federal Unemployment Tax Act (FUTA) taxes
• Tax-free income for children: Children can earn up to the standard deduction amount ($14,600 for 2024) without owing any federal income tax
• Wealth transfer benefits: This effectively converts what would be taxable income for parents into tax-free income for children, creating a powerful wealth transfer mechanism while maintaining family control over the income

Are you eligible to hire your children?

Eligibility for Hiring kids depends primarily on your business structure and the nature of the work performed. The most favorable tax treatment applies to sole proprietorships and spousal partnerships, where significant payroll tax savings are available.

Business structure requirements

1. Sole proprietorships and spousal partnerships—These receive the most favorable treatment and can avoid:
   
   • Social Security and Medicare taxes for children under 18
   • FUTA taxes for children under 21
2. Corporations and non-spousal partnerships—These must pay all standard payroll taxes on wages paid to children, though a workaround exists through establishing a separate sole proprietorship management company

Age and relationship requirements

To qualify for payroll tax exemptions, children must meet these criteria:

• Relationship: Must be legitimate offspring, stepchildren, or foster children
• Age for FUTA exemption: Must be under 21 years old
• Age for Social Security/Medicare exemption: Must be under 18 years old
• Work capability: No minimum age requirement, but the child must be capable of performing legitimate work tasks safely

For more detailed information about business structures and tax implications, visit the IRS Small Business and Self-Employed Tax Center.

What to avoid when hiring your children

Several common mistakes can jeopardize the tax benefits of Hiring kids or trigger unwanted IRS attention. Understanding these pitfalls helps ensure your strategy remains compliant and effective.

Critical mistakes to avoid

1. Unreasonable compensation
   
   • The most critical requirement is that wages must be reasonable for the work performed.
   • The IRS scrutinizes compensation paid to family members
   • Excessive wages relative to the work performed can result in disallowed deductions and potential penalties
   • Research comparable wages for similar positions in your area to establish defensible compensation levels
2. Inadequate documentation
   
   • Poor record-keeping represents a significant audit risk
   • You must maintain the same employment documentation for your children as you would for any other employee
   • Required documentation includes: timesheets, job descriptions, W-4 forms, and payroll records
   • The work performed must be legitimate business activities that contribute value to the operation
3. Hazardous work assignments
   
   • The employment of children under 18 in any hazardous occupation is prohibited.
   • This restriction applies regardless of the family relationship
   • Ensure work assignments are age-appropriate and comply with child labor laws in your jurisdiction

For comprehensive guidance on child labor laws, consult the U.S. Department of Labor's Youth Rules page.

Step-by-step implementation guide

Successfully implementing a Hiring kids strategy requires careful planning and proper documentation. Following a systematic approach ensures compliance while maximizing tax benefits.

Step 1: Establish legitimate job roles

1. Identify genuine business needs that your children can fulfill
2. Create formal job descriptions that outline:
   
   • Specific responsibilities
   • Required skills
   • Performance expectations
3. Ensure work necessity—The work must be necessary for your business operations, not make-work designed solely for tax benefits

Typical appropriate roles include:

• Filing and data entry
• Cleaning and organizing
• Social media management
• Customer service tasks
• Basic administrative support

Step 2: Research fair compensation

1. Use reliable resources like Salary.com or local employment data to determine appropriate wage rates
2. Document your research to support the reasonableness of the compensation
3. Consider key factors:
   
   • Geographic location
   • Complexity of tasks
   • Your child's experience level
   • Local minimum wage requirements

Step 3: Complete employment documentation

Treat your children as you would any other employees by completing these essential forms:

1. Form W-4—For tax withholding elections
2. Form I-9—For employment eligibility verification
3. Employment agreements that specify:
   
   • Job duties
   • Compensation rates
   • Work schedules
   • Performance expectations
4. Separate bank account—Establish a bank account for your child to receive wages, demonstrating their control over the income

Step 4: Implement time tracking systems

Maintain detailed records of work performed:

• Use time tracking apps or manual timesheets to document when and how long your child worked
• Include task descriptions—Document specific work performed during each period
• Maintain consistency—Keep records according to the same standards you use for other employees
• Store securely—This documentation becomes crucial if the IRS questions the legitimacy of wages paid

Step 5: Process regular payroll

1. Set up payroll systems—Add your child to your regular payroll system
2. Issue paychecks consistently—Maintain a regular payment schedule
3. Handle tax reporting—Issue Form W-2 at year-end just as you would for other employees
4. Maintain payroll records according to standard business practices, including tax withholding and reporting requirements

Calculating your potential tax savings

The tax savings from Hiring kids depend on several factors, including your business structure, the child's age, wages paid, and your effective tax rate. Understanding these calculations helps you optimize the strategy for maximum benefit.

Payroll tax savings calculation

For sole proprietorships and spousal partnerships, significant payroll tax savings are available:

• Children under 18 are exempt from the combined 15.3% Social Security and Medicare taxes (7.65% employee portion plus 7.65% employer portion)
• Children under 21 are exempt from the 6% FUTA tax on wages up to $7,000 annually

Example calculation: If you pay your 16-year-old child $10,000 annually, your payroll tax savings would include:

1. Social Security and Medicare taxes: $10,000 × 15.3% = $1,530
2. FUTA taxes: $7,000 × 6% = $420
3. Total payroll tax savings: $1,950

Income tax savings calculation

The business benefit works through these mechanisms:

1. Business deduction: The business deducts the full amount of wages paid, reducing taxable income dollar-for-dollar
2. Tax rate application: If your effective tax rate is 32%, paying your child $14,600 (the 2024 standard deduction) would reduce your income taxes by approximately $4,672
3. Child's tax liability: Meanwhile, your child pays zero income tax on this amount due to the standard deduction

Combined savings example

Consider a family business paying two children ages 15 and 17, a combined $25,000 annually:

Tax savings breakdown:

1. Business income tax savings: $25,000 × 32% = $8,000
2. Social Security/Medicare tax savings: $25,000 × 15.3% = $3,825
3. FUTA tax savings: $14,000 (combined wages subject to FUTA) × 6% = $840
4. Total annual savings: $12,665

Refer to the IRS Publication 15 (Circular E) Employer's Tax Guide for detailed tax rate information and current limits.

Required documentation and compliance

Proper documentation is essential for defending the Hiring kids strategy during an IRS audit. Maintaining comprehensive records demonstrates the legitimacy of the employment relationship and supports the tax positions claimed.

Essential employment records

Maintain copies of all standard employment documents:

• Form W-4—Completed tax withholding form for each child employee
• Form I-9—Employment eligibility verification documentation
• Job descriptions—Detailed specifications of duties, qualifications, and performance expectations
• Business justification—Documentation of the business need for the position and how the work contributes to business operations

Time and wage documentation

Implement systematic record-keeping that includes:

1. Time tracking records showing:
   
   • Dates and hours worked
   • Specific tasks performed during each work period
   • Clear documentation of work quality and completion
2. Payroll documentation including:
   
   • Gross wages for each pay period
   • Tax withholdings (if applicable)
   • Net pay calculations
   • Copies of paychecks or direct deposit records
3. Banking records showing:
   
   • Wage deposits to the child's account
   • Bank statements demonstrating the child's control over earned income

Supporting business justification

Document the business case for hiring your children:

• Business needs assessment—Explanation of how their work contributes to business operations and revenue generation
• Market rate research—Records showing research into prevailing wage rates for similar positions in your area
• Performance evaluations—Regular assessments of work quality and productivity
• Training documentation—Records of any job-related training provided to child employees

For comprehensive recordkeeping guidelines, consult the IRS Business Expenses publication.

Real-world application example

The Johnson family operates a successful landscaping business structured as a sole proprietorship. They decided to hire their three children, ages 14, 16, and 19, for various business tasks during the summer months and after school.

Job assignments and compensation

Child #1 (Age 14):

• Role: Basic office tasks like filing and answering phones
• Schedule: 10 hours per week at $12 per hour
• Annual compensation: $6,240

Child #2 (Age 16):

• Role: Social media management and customer communications
• Schedule: 15 hours weekly at $15 per hour
• Annual compensation: $11,700

Child #3 (Age 19):

• Role: Landscaping work and equipment maintenance
• Schedule: 20 hours per week at $18 per hour
• Annual compensation: $18,720

Total yearly wages paid: $36,660

Annual tax savings breakdown

The Johnson family's tax savings include:

1. Payroll tax savings: 

• Social Security/Medicare taxes saved (ages 14 & 16): $17,940 × 15.3% = $1,766
• FUTA taxes saved (all three children): $21,000 × 6% = $1,260
• Total payroll tax savings: $3,026

2. Income tax savings:

• Business deduction: $36,660 × 32% effective rate = $11,731
• Children's tax liability: $0 (all earn less than the standard deduction)

3. Total annual savings: $14,757

This arrangement provides the Johnson family with substantial tax savings while giving their children valuable work experience and financial education.

Compliance considerations and best practices

Maintaining compliance with Hiring kids strategies requires ongoing attention to documentation, compensation levels, and regulatory requirements. Following best practices helps ensure the strategy remains defensible and effective over time.

Ongoing compliance requirements

1. Regular compensation reviews
   
   • Periodically review wage rates to ensure they remain reasonable compared to market rates.
   • Document any wage increases with business justifications and market research.
   • Avoid dramatic compensation increases that might appear unreasonable to the IRS.
2. Work assignment guidelines
   
   • Ensure all work assignments are age-appropriate and comply with federal and state child labor laws.
   • Maintain clear boundaries between family and work time to demonstrate the employment relationship's legitimacy.
   • Document training and skills development are provided as children gain experience.
3. Record retention practices
   
   • Maintain employment records for at least four years after the tax year.
   • Store documentation in organized, easily accessible formats in case of an audit
   • Consider digital storage systems with proper backup procedures to ensure records remain available.

Best practices for long-term success

• Treat children as legitimate employees—Apply the same standards and expectations for any other employee.
• Separate business and family relationships—Maintain professional boundaries during work hours.
• Regular performance reviews—Conduct formal evaluations to document work quality and improvement
• Stay current with regulations—Keep up-to-date with changes in tax laws and child labor regulations.s
• Professional consultation—Work with qualified tax professionals to ensure ongoing compliance

Maximizing long-term benefits

The Hiring kids strategy offers long-term wealth-building and tax-planning opportunities beyond immediate tax savings. Consider these advanced applications to maximize the strategy's effectiveness over time.

Advanced wealth-building strategies

1. Retirement savings opportunities
   
   • Children with earned income can contribute to Roth IRAs, creating tax-free retirement savings that can grow for decades.
   • A child contributing $6,000 annually to a Roth IRA at age 16 could accumulate over $1.2 million by retirement age, assuming 7% annual returns.
2. Education funding strategies
   
   • Wages paid to children can fund education expenses directly or through 529 college savings plans.
   • This approach provides more flexibility than traditional college funding methods while maintaining family control over the funds.
3. Business succession planning
   
   • Involving children in the business through legitimate employment creates opportunities for gradual ownership transitions.
   • Children gain valuable business experience while parents maintain operational control during the transition.
   • Early involvement helps identify children interested in continuing the family business.

Leveraging Hiring kids strategies with Instead

Implementing and optimizing the Hiring kids strategy requires careful attention to compliance requirements, documentation standards, and tax calculations. Instead's AI-powered platform simplifies this process by automating calculations, generating required documentation, and ensuring compliance with current regulations.

How Instead helps family businesses

Instead provides comprehensive support for implementing Hiring kids strategies:

• Automated calculations—Identifies optimal wage levels based on your specific business structure and family situation
• Documentation management—Tracks required documentation and maintains audit-ready records
• Compliance monitoring—Ensures adherence to current IRS requirements and child labor laws
• Integration capabilities—Connects with existing payroll and accounting systems to streamline implementation
• Tax savings optimization—Calculates maximum tax benefits across different business structures and scenarios

By utilizing Instead's comprehensive approach to tax strategy implementation, family businesses can confidently deploy Hiring kids strategies while maximizing tax benefits and maintaining full compliance with IRS requirements.

Frequently asked questions

Q: Can I hire children under age 8 in my business?

A: While there's no specific minimum age requirement in the tax code, children must be capable of performing legitimate work safely and effectively. Most tax professionals recommend age eight or older for basic tasks like filing or cleaning.

Q: What happens if my child earns more than the standard deduction?

A: Income above the standard deduction is subject to income tax at the child's tax rates, typically lower than the parents'. However, the "kiddie tax" may apply to unearned income for children under 19.

Q: Can I hire my children if I operate as an LLC?

A: LLC tax treatment depends on the election made. Single-member LLCs taxed as sole proprietorships qualify for payroll tax exemptions, while LLCs electing corporate taxation do not.

Q: How do I handle workers' compensation insurance for child employees?

A: Check with your workers' compensation carrier about coverage requirements for child employees. Some states may have special provisions or exemptions for family members working in small businesses.

Q: What records should I keep if audited by the IRS?

A: Maintain comprehensive employment files including job descriptions, timesheets, payroll records, bank statements showing wage payments, and documentation supporting wage reasonableness. Keep these records for at least four years after filing the related tax return.

Q: Are there any restrictions on the type of work my children can perform?

A: Federal and state child labor laws restrict certain types of work for minors. Children under 18 cannot work in hazardous occupations, and there may be additional restrictions based on age and work hours. Always consult current labor law requirements for your jurisdiction.

Q: How do I determine if my wages are reasonable?

A: Research comparable wages for similar positions in your area using resources like salary surveys, local job postings, and industry data. Document your research to support the reasonableness of compensation levels. The wages should align with what you would pay an unrelated employee for the same work.

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