HOW TO HIRE YOUR KIDS AND THE TAX BENEFITS.
Sometimes parents have gotta put their kids to work whether the reason being character building, or an actual need for them to earn money, or for the parents to get help. There’s also another reason, tax benefits.
To get these benefits for yourself and your children, you need to know the do’s and don’ts because we don’t want to piss off the IRS, get you audited, and incur penalties.
The benefits
Some folks hear tax benefits and immediately dive in without thinking whether those benefits are even, well, beneficial to them. This tax benefit allows you to pay your kids and save tax dollars. However, that’s still only a benefit if you can afford to and want to pay your kids, and I don’t see people ever talking about that.
Here’s what I mean. You pay Timmy $5,000. Great. That saves you, let’s say, $1,000 in taxes. Awesome. It’s still a net loss to your bank account of $4,000. This absolutely makes sense if you:
Tend to give Timmy an allowance anyway, but this is more of a win/win, or
You want to and can afford to set Timmy up for future success by putting that money into savings.
However, if you’re doing this just for the tax savings while piling up tax debt or credit card debt, it might not be the best move. Spending $5,000 to save $1,000 leaves you with $4,000 less to pay those balances. You hear me bestie? If you want to learn more about deductions and taxes generally, read this post.
Ok, if you’re still on board and thinking “absolutely, it makes sense to pay my kids and get the benefits,” let us continue on.
We’ve got more posts
If you need to learn all the tax things, start here with this post.
Also, check out all the other available deductions with our ultimate small business tax guide.
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How Much to Pay
You must pay real and reasonable amounts for actual work.
Growing up, I spent about half my summers from age 9 to about 13 roofing with my dad. He paid me minimum wage, $5.25 per hour cash. I hated it, but it got me out of the house. I bought myself a bike one summer and an Xbox the next.
At first, he’d just have me walk around with this big magnet thing on wheels to pick up any nails that may have been dropped into the client's yard. Once I got a bit older, I was entrusted with a box knife to cut shingles as needed. Then, I advanced to roof demolition.
Dad gave me tasks I could reasonably manage each summer given my age and ability. When I’d go back to help in high school, I was finally strong enough to carry 70 pound packs of shingles up the ladder. You wouldn’t ask a 9 year old to that.
And that pretty well exemplifies the tax rules here.
You must ensure when hiring your kids that they are completing actual work reasonable for their age, experience, and abilities.
That’s the first part to the rule.
You must also pay them a reasonable wage.
It would not have been reasonable for dad to pay me the same as his other, adult contractors who could do twice the work I could.
So basically…
Only pay your kids for stuff they can (and should) actually be doing, and
Don’t let nepotism impact the wage.
How does this actually work
Hiring your kids does not necessarily mean that you need to put them on payroll or issue a 1099 at the end of the year. Any child that is under the age of 18 can be paid from your business up to the standard deduction (which changes from year to year, for 2023 it was $13,850), without having to file a tax return or pay taxes. It’s a logical rule because the deduction will reduce any income they earned to $0.
Just note that reasonable wage again. If they work 200 hours during the year at $15 per hour, you would pay them $3,000. You can just round up to $10,000 for the tax benefits. And note that the amount of hours worked should also be reasonable. Having your 5th grader clean your office once a week for an hour, great. Filing papers a few hours a month sure. Working your front desk 8 hours a day during the summer? Maybe not. Also, we’re not talking about child labor laws here. That’s a different post. If they are underage, ensure you’re familiar with the laws regarding breaks and maximum hours allowed to be worked.
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Contractor or Employee?
Generally, you can pay your kids as a contractor without having to issue them a 1099 or as an employee via a W-2.
If the business is solely owned by one parent or by both parents with no other non-parent owners, it makes the most sense to pay the kids as contractors. Bank transfers or checks are best. Not cash. Make note of what the payment is for. Records are important in case you have future IRS issues. Deposit the funds in your child’s bank account.
If the IRS decides to ask for proof, you will need to ensure you can substantiate the tasks they complete. In order to do that, ensure you are keeping records of their times and their workload just like you would any other employee.
Another way to substantiate the wages paid to your child depending on how much you pay them would be to assist them in filing a tax return so they are also claiming the income you are saying you are paying out to them. If they received a W-2, even if you are claiming them, a tax return can, and probably should, be filed. Just ensure your tax preparer or TurboTax knows you are claiming them to ensure there are no errors in filing. If they are paid above the current standard deduction, they are required to file.
Unfortunately, if your child is over the age of 18, they will need to pay the necessary taxes depending on if you decide to pay them as a contractor or an employee. You are able to provide a W-2 for any children under the age and not have to pay FICA, payroll taxes, and they will not need to pay Medicare taxes or Social Security taxes.
What to do with the money
This is a question that may be best life to your financial planner, but, as we’re talking about not huge sums of money, we may be able to keep things simple.
Roth IRAs are a great route. For more on how those work checkout this blog. You can contribute up to $6,500 per year (in 2023). Those funds then grow tax free until the kid’s retirement, which is a fantastic way to give them a head start.
You can also look into college savings vehicles or high yield savings accounts. There’s also nothing wrong with letting kids manage those funds for themselves once old enough. They could use the savings towards their first car, movies with friends, etc.
Ultimately, that’s up to you friend.
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