Hiring your children to work as legitimate employees in your business is a great tax strategy. Indeed, the higher your own taxes are, the more you'll save by hiring your kids.
But beware: The IRS is on the lookout for taxpayers who abuse this tax strategy.
If you hire your children as employees to do legitimate work in your business, you may deduct their salaries from your business income as a business expense. Moreover, if your child is under 18, you won't have to withhold or pay any FICA (Social Security or Medicare) tax on the salary, subject to a couple of exceptions.
These rules allow you to shift part of your business income from your own tax bracket to your child's bracket—which should be much lower than yours unless you earn little or no income. This tactic can result in substantial tax savings.
Your child will have to pay tax on the salary you pay them only to the extent it exceeds the standard deduction amount for the year. Fortunately, the standard deduction is quite large. For 2022, it is $12,950 for single taxpayers. So, your child can earn up to $12,950 (that's $1,079 per month) and owe no tax on the income.
If you pay your child more than $12,950 per year, they'll only have to pay tax at the rates shown in the following chart:
|
2022 Income Tax Rate |
Single Taxpayers |
|
10% |
$0 - $10,275 |
|
12% |
$10,276 - $41,775 |
|
22% |
$41,776 - $89,075 |
|
24% |
$89,076 - $170,050 |
|
32% |
$170,051 - $215,950 |
|
35% |
$215,951 - $539,900 |
|
37% |
over $539,900 |
Thus, your child could earn $23,225 ($12,950 + $10,275) and have to pay a total of only $1,027 income tax (($23,225 - $12,950) x 10% = $1,027).
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. And they'll have to pay tax on their benefits.
To avoid this situation, you should follow these simple rules.
First of all, your children must be bona fide employees. Their work must be ordinary and necessary for your business, and their pay must be for services actually performed.
Their services don't have to be indispensable, only common, accepted, helpful, and appropriate for your business. Any real work for your business can qualify.
You get no business deductions when you pay your child for personal services, such as babysitting or mowing your lawn at home.
On the other hand, the money you pay for yard work performed on business property could be deductible as a business expense. Your child can probably help you with lots of business-related tasks, such as answering phones, helping with your website, or cleaning the office.
The IRS has accepted that a seven-year-old child may be an employee. But it probably won't believe that children younger than seven are performing any useful work for your business.
You should keep track of the work and hours your children perform. Many apps are available for this purpose, or you can create a timesheet yourself with a spreadsheet or on paper. It should list the date, the services performed, and the time spent performing the services.
Although not legally required, it's also a good idea to have your child sign a written employment agreement specifying their job duties and hours. These duties should be related only to your business.
When you hire your children, it is advantageous (tax-wise) to pay them as much as possible. That way, you can shift as much of your income as possible to your children, who are probably in a much lower income tax bracket.
However, you can't just pay any amount you choose: Your child's total compensation must be reasonable. This amount is determined by comparing the amount paid with the value of the services performed.
You should have no problem as long as you pay no more than what you'd pay a stranger for the same work—don't try paying your child $100 per hour for office cleaning just to get a big tax deduction. Find out what workers performing similar services in your area are being paid. For example, if you plan to hire your teenager to help answer the phone, call an employment agency or temp agency in your area to see what these workers are being paid.
To prove how much you paid (and that you actually paid it), you should pay your child by check or direct deposit, not cash. Do this once or twice a month as you would for any other employee. The funds should be deposited in a bank account in your child's or spouse's name. Your child's bank account may be a ROTH IRA, Section 529 college savings plan, or custodial account that you control until your child turns 21.
Finally, you must comply with most of the same legal requirements when you hire a child as you do when you hire a stranger. So, you must fill out IRS Form W-4 and complete U.S. Citizenship and Immigration Services (USCIS) Form I-9, Employment Eligibility Verification.
You must also record your employee's Social Security number. If your child doesn't have a number, you must apply for one. In addition, you, the employer, must have an Employer Identification Number (EIN). If you don't have one, you may obtain it online at the IRS website (www.IRS.gov) or by filing IRS Form SS-4.
You must also complete and file IRS Form W-2 each year showing how much you paid your child.
If you have any questions about how you can save taxes by hiring your children, contact a tax lawyer.