Why hiring your children might be a good idea?

As a parent, we know how expensive raising a child is.  Not only are the necessities expensive but then you add extracurricular activities, and the amount is crazy.  Lending Tree looked at data at the national and state levels of the cost of raising a small child.  According to the study, families are projected to spend $237,482 over 18 years to raise a child.  WOW!  Hiring your kids to work in your business might just lessen the blow…a bit.

When hiring your children to work in your business, you get to write-off their salaries.  Your children must pay taxes on their salary only if it exceeds the standard deduction amount for that year.  The standard deduction for 2024 is $14,600which means you can pay your children up to $14,600 annually and they will not have to pay tax on that income.  Sounds too good to be true, huh?  The following are the IRS tax rules for hiring your children:

1.      Reasonable Compensation:  The wages paid to your children must be reasonable for the work they did.  For example, if you hire your 7-year-old to help put flyers on car windows for a couple of hours, paying them $14,600 for doing just that seems a bit high.  You must pay your children exactly what you would pay a nonfamily member for doing the same work.

2.      Must be authentic and legal:  Your children will need to fill out Form W4and I-9.

3.      Documentation:  It is crucial to keep accurate records of the hours worked, the duties performed, to ensure compliance with all tax laws and regulations.

The way you have your business structured will determine whether you need to withhold payroll taxes from your child’s paycheck.

1.      Sole Proprietorship, LLC, or Partnership(both parents are partners):  If your children are under 18 years old, you do not have to withhold FICA (social security) or Medicare taxes from their wages.

2.      S Corporation or C Corporation:  Regardless of your children’s ages, you will have to withhold FICA and Medicare taxes.

You can combine this strategy with an IRA or 401K to really maximize the benefit.  For example, if you pay your child $14,600, you could put $3,650 into a SEP IRA for them.  This results in your getting a $18,250 tax write-off and your kid pays $0 in taxes. With a 401K, the tax savings are even greater.

As mentioned above, when your business is an S Corporation or C Corporation, you must withhold FICA and Medicare taxes from their wages but wait…. There is a workaround. Instead of paying your children directly from your S or C Corporation, you set up a family management company whose only purpose is to support the operations of your business.  This support can be scheduling the jobs your children do, bookkeeping and managing the documentation on the jobs.  The family management company charges a management fee from your corporation and then pays your children directly from the management company which is a sole proprietorship.  Now you can pay your children up to $14,600 without having to withhold any taxes.

If you would like to learn more about hiring your children and if that is the right strategy for you, please reach out to us for consultation.  Or you can listen to our Podcast “Wealthy Wallet” for more information.