If you own a business, hiring your children to do legitimate work for you has always been a great tax strategy. Now, as a result of the Tax Cuts and Jobs Act (TCJA) that took effect in 2018, it's not simply great, it's fantastic.
Here's why: When you hire your child as an employee in your business, you get to deduct his or her salary as a business expense. That’s beneficial by itself. But it gets better: Your child will have to pay tax on the salary only to the extent it exceeds the standard deduction amount for the year. The TCJA almost doubled the standard deduction. For 2019, it is $12,200 for single taxpayers. That means your child can earn $12,200 in annual employee income and pay zero income taxes on it. This is by far the largest amount children have ever been able to earn from a job tax-free.
Example: Carol hires Mark, her 16-year-old son, to perform data entry services for her accounting business, which she owns as a sole proprietor. He works ten hours per week and she pays him $20 per hour (the going rate for such work). Over the course of a year, she pays him a total of $12,000. When she does her taxes for the year, she may deduct his $10,000 salary from her business income as a business expense. Since Mark’s salary is less than the standard deduction, he pays zero income tax on it.
Moreover, if your child is under 18, you won’t have to withhold or pay any Social Security or Medicare tax on the salary (subject to a couple of exceptions). Also, you won't have to withhold income taxes from your child’s pay unless his or her earned income exceeds the standard deduction. However, you must withhold income taxes if your child has more than $350 in unearned income (for example, interest or dividend income) and his or her total income exceeds $1,100 (in 2019).
You can pay your child more than the standard deduction amount and still come out way ahead on your taxes. This is because your child will likely be in a much lower tax bracket than you. For example, in 2019, a child need only pay a 10% tax on taxable earned income up to $9,700—taxable income means total income minus the standard deduction. Thus, a child could earn up to $21,900 and pay only a 10% income tax on $9,700 of it—that’s $970 in tax on $21,900 in income.
The IRS is well aware of the tax benefits of hiring a child, so it’s on the lookout for taxpayers who claim the benefit without really having their children work in their businesses. If the IRS concludes that your children aren’t really employees, you’ll lose your tax deductions for their salary and benefits.
You must hire your child to do real work in your business, which must also be real. This can be any type of work as long as it is necessary for your business and your child really does it. For example, you could employ your child to clean your office, answer the phone, input data, or make deliveries (a child may only make deliveries by foot or bicycle, not by car). You get no business deductions when you pay your child for personal services, such as baby sitting or mowing your lawn at home. On the other hand, money you pay for yard work performed on business property could be deductible as a business expense.
You should keep track of the work and hours your children perform by having them fill out timesheets or timecards.
You must also pay your child a reasonable amount for the work he or she does. You shouldn't overpay simply because it saves you taxes. To prove how much you paid (and that you actually paid it), you should pay your child by check or electronic deposit, not cash.
Finally, you must comply with most of the same legal requirements when you hire a child as you do when you hire a stranger. These include filing employment tax returns. These rules are explained in detail in IRS Publication 15, Circular E, Employer’s Tax Guide, and Publication 929, Tax Rules for Children and Dependents.