If you’re like most parents, you want to do everything you can to help your child be successful.
One way to do that is to hire your child as an employee and save on taxes. It’s a great way to give your child a head start in life while also reducing your tax bill.
Here’s what you need to know about hiring your child and saving money on taxes.
1. Advantages of Hiring Your Child as an Employee
The advantages of hiring your child as an employee include:
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- Directing their salary towards a Roth IRA, 529 Savings Plan, or other tax-advantaged account where it can grow tax free.
- Deducting their salary on your personal tax return to reduce your annual tax liability.
- Instilling values of hard work, discipline, saving and investing.
2. Compliance
Hiring your child is not the same as paying your child to do chores.
Once your child’s efforts impact your business and taxable income, you must comply with the IRS and Department of Labor.
Areas of compliance include:
- Assigning your child ordinary and necessary duties for your business.
- Providing a written employment agreement.
- Obtaining a work permit and any other state form required for employed minors.
- Completing forms W-4 & State Withholding (see Entity Structure section).
- Providing them with a W-2 (or 1099) and file Form W-3 (or 1096) by the applicable deadline under the current tax law.
3. Compensation
Just like an adult employee, your child must receive a reasonable compensation.
That’s right.
So, you probably shouldn’t pay your 6 month-old $20,000 per week to pose for your new business’ marketing materials.
On a positive note, while keeping compensation reasonable, you can also keep it tax-free by paying them an annual salary that is below the standard deduction.
4. Taxes
Currently, the federal government does not tax minors’ income below the standard deduction, which is $12,950 in 2022.
If any child’s job pays them less than this amount in a year, then the child normally would not owe income tax on that income.
This is because the amount each child earns, up to $12,950, gets added to the standard deduction—leaving them with no taxable income.
However, if a child earns more than this figure during the year, then they would have to pay taxes on that money.
For example, if a child makes $12,900 at their job in 2022, then they would owe no tax on that money because their earnings were under the standard deduction.
But if they earned $13,100 in 2022, then they have to pay income tax for it after subtracting the standard deduction, which is $12,950.
Types of Tax
If you have ever received a W-2, you are well aware of the many different types of tax that impact your net earnings.
Fortunately, when you hire your child, not all of those taxes apply –
Income Tax Withholding
- Payments for the services of a child are subject to income tax withholding regardless of age. Even though the child might not have an income tax liability, withholding might still apply.
Social Security and Medicare
- Payments for the services of a child under age 18 are not subject to social security and Medicare taxes. If the child is 18 years or older, then payments for the services of a child are subject to social security and Medicare taxes.
Federal Unemployment Tax
- Payments for the services of a child under age 21 are not subject to Federal Unemployment Tax Act (FUTA) tax. If the child is 21 years or older, then payments for the services of a child are subject to FUTA taxes.
Kiddie Tax
- Although the Kiddie Tax is applied to unearned income, it is important to separate the earned income tax rate from the unearned income tax rate. To learn more about the Kiddie Tax, See 8 Facts About the Kiddie Tax.
5. Entity Structure
According to the IRS, if the business is a parent’s sole proprietorship or a partnership in which each partner is a parent of the child, the tax advantages listed above apply.
However, if the business is a corporation, a partnership (unless each partner is a parent of the child), or an estate (even if it is the estate of the deceased parent of the child), payments for services of a child are subject to income tax withholding, social security taxes, Medicare taxes and FUTA taxes regardless of age.
6. College Financial Aid
Parents and children should keep in mind that a child’s earned income could impact their eligibility for college financial aid.
Currently, a student’s earned income counts towards a percentage of their expected family contribution, which could limit the amount of aid they receive.
So, Should You Hire Your Child as an Employee?
If you have ever asked a financial advisor this question, you already know the answer…
It depends!
In making your decision, be sure to consult with an employment attorney, CPA or other professional advisor to ensure you are compliant with all federal and state laws.
For instance, your professional advisor might advise you to file a Form I-9 or unemployment reports on behalf of your minor employees.
Or, they might tell you that your child employee does not meet your state’s minimum age requirement.
This might seem like a lot of work, but, with the right professional on your team, the effort will be seamless and well worth it.
When done correctly, hiring your child can provide financial and developmental benefits that will last a lifetime.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisers before engaging in any transaction.
