Legally Hiring Your Children and Maximize Tax Savings: A Beginner’s guide

Hiring your children to work in your business, itsn’t just a great way to instill a strong work ethic and teach valuable skills — it can also provide significant tax savings. Many business owners are unaware of the tax benefits that come with employing their children, and when done correctly, this strategy can reduce payroll taxes, shift income to a lower tax bracket, and allow for deductions that reduce your taxable income.

In this detailed guide, we’ll walk you through the legalities of hiring your children, how to comply with IRS guidelines, and the best strategies to maximize your tax savings. By understanding how to structure family employment properly, you can reap financial rewards while staying fully compliant with tax laws.

The Legality of Hiring Your Children

Hiring your children, including your children, is completely legal in the U.S. and comes with multiple benefits if managed properly. Many business owners leverage this practice to take advantage of tax breaks that are unique to family employment.

The IRS allows businesses to deduct wages paid to family members, as long as they follow certain guidelines, such as paying reasonable wages for legitimate work. Understanding these rules is essential to avoid any potential legal issues and to maximize the financial benefits of hiring your children.

While hiring your children can help lower your business’s tax burden, it’s important to follow all federal, state, and local employment laws, including child labor laws. By adhering to these rules and documenting everything carefully, you can enjoy the tax savings without risking an audit.

IRS Guidelines on Hiring Your Children

The IRS is clear on the tax benefits associated with hiring your children, particularly children. However, there are strict rules that must be followed to ensure you remain in compliance with tax laws. When you legally hire your children, you can deduct their wages from your business income, but only if certain conditions are met.

Key IRS Guidelines

1. Reasonable Compensation: The wages you pay your children must be reasonable and commensurate with the type of work they perform. For example, if you hire your child to assist with filing paperwork, you can’t pay them an executive-level salary.
2. Legitimate Work: The job must be necessary for the operation of the business. You can’t pay your child for doing no work or for tasks that aren’t beneficial to your business.
3. Employment Relationship: There must be a clear employer-employee relationship between you and your child. This means setting clear job expectations, documenting work hours, and issuing proper payroll documentation.

Following these guidelines ensures that you stay compliant with IRS regulations and avoid any potential penalties.

Age Requirements and Labor Laws to Consider

When hiring your children, particularly your own children, it’s crucial to adhere to child labor laws that regulate the type of work, the number of hours, and the conditions under which children can be employed.

Federal and State Labor Laws

Federal law under the Fair Labor Standards Act (FLSA) sets restrictions on child labor, but these laws are generally more lenient when it comes to family businesses. For example, children under 18 are restricted from working in hazardous jobs, but children of any age can generally work in non-hazardous jobs within their family-owned business.

• Children Under 14: Federal law prohibits most employment for children under the age of 14, but there is an exception for children employed by their parents in a family-owned business, as long as the work is not hazardous.
• Children Aged 14-15: They may work limited hours in non-hazardous jobs, such as office or clerical work, even in non-family businesses, and may work longer hours during non-school periods.
• Children Aged 16-17: These teenagers can work in a broader range of jobs, though hazardous work is still off-limits.

Creating Job Roles that Qualify for Tax Deductions

When creating job roles for your children, it’s important to ensure that the duties they perform are necessary and contribute to the business. The IRS scrutinizes family employment, so make sure the roles are real and not just created for the sole purpose of receiving tax benefits.

Examples of Legitimate Job Roles

• Administrative Work: Filing documents, organizing inventory, answering phones, and helping with bookkeeping are all legitimate tasks for children in a family business.
• Marketing and Social Media: If your child has skills in digital marketing or social media, you can hire your children to help promote your business online.
• Manual Labor: For businesses that require physical work like landscaping, packing, or delivery, your child can be legitimately hire your children to assist in these areas.

By clearly defining your child’s role and ensuring that they have real responsibilities, you create a legitimate basis for wage deductions.

Payroll Considerations for Family Employees

When you hire your children, you must treat them like any other employee when it comes to payroll. This means setting up a proper payroll system, issuing paychecks, and withholding necessary taxes.

Payroll Taxes and Exemptions

One of the biggest benefits of hiring your children is the potential exemption from certain payroll taxes. If your child is under 18 and you own a sole proprietorship or a family partnership, their wages are not subject to Social Security and Medicare taxes (FICA). Additionally, if your child is under 21, their wages may be exempt from Federal Unemployment Tax (FUTA).

However, if you run an S-corporation or C-corporation, these payroll tax exemptions do not apply, and you must withhold payroll taxes from their wages as you would for any other employee.

Reporting Wages for Family Members to the IRS

All wages paid to family members, including children, must be reported to the IRS just like those paid to any other employee. This involves issuing the appropriate tax forms and making sure that the compensation is reported correctly on your business’s tax return.

Key Reporting Steps

1. W-2 Forms: You must issue a W-2 form to your child at the end of the year to report their wages. Make sure that the wages reported are reasonable and reflect the work performed.
2. Withholding Taxes: Depending on the age of the child and your business structure, you may be required to withhold certain taxes, including federal and state income taxes, Social Security, Medicare, and unemployment taxes.
3. Business Tax Return: The wages you pay to your child are deductible on your business’s tax return, which reduces your taxable income.

By following these reporting steps, you’ll ensure that you stay compliant with IRS guidelines while claiming valuable tax deductions.

Understanding Tax Exemptions for Child Employees

One of the most significant tax advantages of legally hiring your children is the ability to exempt their wages from certain taxes. As mentioned earlier, if your child is under 18 and you operate a sole proprietorship, their wages are exempt from Social Security and Medicare taxes.

Additionally, if your child earns less than the standard deduction amount, which is currently $13,850, they are not required to pay federal income taxes. This means that, in many cases, the income your child earns could be entirely tax-free.

Shifting Income to Lower Tax Brackets

Another way to maximize tax savings is to shift income to your children, who are likely in a lower tax bracket. By paying your child reasonable wages, you reduce your business’s taxable income and potentially shift that income into a lower tax bracket, resulting in significant tax savings for your family as a whole.

Recordkeeping and Documentation for Tax Purposes

To avoid issues with the IRS, it’s crucial to maintain detailed records and documentation when employing your children. Proper documentation not only helps you stay compliant but also protects you in the event of an audit.

Key Records to Keep

1. Job Descriptions: Clearly define your child’s role within the business, including the tasks they are responsible for and the hours they work.
2. Timecards: Keep track of your child’s work hours, just as you would with any other employee. This provides evidence that they are actually performing work for the business.
3. Payroll Records: Maintain detailed records of wages paid, including pay stubs, check copies, and tax withholding information.
4. Receipts for Business Expenses: If your child incurs any business-related expenses, such as travel or supplies, make sure you keep receipts and document the purpose of those expenses.

Having thorough records helps ensure that your family employment practices are legitimate and that you can defend your tax deductions if necessary.

Steps to Implement Family Employment for Tax Savings

Now that you understand the benefits and legal requirements of hiring your children, here are the steps you can take to implement this strategy in your business:

1. Identify Legitimate Job Roles: Assess your business needs and identify roles that your children can reasonably fill. Make sure the tasks they perform are necessary and contribute to the business.
2. Set Up Payroll: Create a payroll system that accurately tracks wages, hours worked, and tax withholdings. Be sure to follow all IRS guidelines for reporting wages.
3. Document Everything: Maintain detailed records of your child’s work, including job descriptions, timecards, and payroll records. This documentation is essential for defending your deductions.
4. Consult with a Tax Professional: Work with an accountant or tax advisor to ensure you are following all legal requirements and maximizing your tax savings. A professional can help you navigate the complexities of family employment and make sure you are in full compliance with the law.

By following these steps, you can successfully hire your children in a way that maximizes tax savings while staying compliant with IRS regulations.

FAQs

Final Thoughts: Maximizing Tax Savings Legally

Hiring your children as employees in your business is a powerful tax-saving strategy, but it must be done legally and ethically. By paying your children reasonable wages for legitimate work, following labor laws, and maintaining proper documentation, you can reduce your business’s tax burden and shift income to lower tax brackets.

The key to success with family employment is compliance. The IRS closely monitors family employment to prevent abuse, so it’s essential to follow all guidelines carefully. When done correctly, hiring your children can be a win-win, helping your business grow while providing valuable tax savings.