Should You Hire Your Children?
If you own your own business, it’s normal to think about hiring your children. Family members can be a source of help with your company, and you may have heard that hiring your kids offers several financial benefits. However, hiring children can lead to an increase risk of audits, so it’s important to weigh the pros and cons, and understand the rules fully before you consider bringing your children on board.
Special Considerations for S Corps and C Corps
Before we dive into the benefits and drawbacks of hiring your children, you should know that if you own an S Corp or C Corp the IRS rules for family help in a business are different than for less formal businesses, like sole proprietorships and single-member LLCs.
Specifically, if one or both parents are the sole proprietors or owners of the business, you don’t have to pay FICA taxes (Social Security and Medicare taxes) for your minor child under 18. This is a tax savings of more than 15%.
Also, the same business entities don’t have to pay federal unemployment taxes (FUTA taxes) on wages earned by a child under 21. Giving your child unemployment tax-free wages is one way of keeping more money in the family.
However, if you have an S Corp or C Corporation, you must pay these payroll taxes, even if you employ your children. That significantly eats into the tax advantages of hiring your child.
When it comes to risk, S Corps are at a greater risk of an audit when owners hire their children. Risking an audit means more than increased paperwork and a run in with the IRS. If hiring your child is not considered an arms length transaction (meaning you wouldn’t pay an unrelated person the same amount of money for equivalent work), it could invalidate your S election. If this happens, you have to pay back all the savings from the S Corp election from the S election date with penalties and interest.
If you’re an S Corp or C Corp owner, we don’t recommend paying your children from your business. There’s very little tax benefit, given that you will need to pay payroll taxes on your child’s salary. And you take on more risk, which could come with a signiciant financal cost. Overall the risks you incur from hiring your children far outweigh any tax or financial benfits.
Pros and Cons of Hiring Your Children
Here are some pros and cons to consider when it comes to hiring your children:
Pro: Tax Benefits
Tax deductions are among the most commonly-discussed reasons to hire your kid. Income taxes increase as you earn more, so if your kids don’t make a lot of money, they won’t pay as high a tax rate.
As long as your dependent child earns less from their job than the standard deduction, they do not need to file a tax return and do not owe federal income taxes. That means if your child earns less than $13,850 in 2023, they enjoy tax exemption on their income.
If you’re a parent in a relatively high tax bracket, shifting taxable income to your child with no tax liability – assuming they make less than the standard deduction amount – can give you a significant tax break.
Depending on the structure of your company, you could also avoid payroll taxes. In effect, you can pay your kids slightly more than $13,000 yearly without paying any standard payroll taxes. Remember, if you’re an S Corp or C Corp owner, you will need to pay payroll taxes on your child wages, which significantly reduces any tax benefit.
Some parents may be nervous to hire their child because they’ve heard of the Kiddie Tax, but this tax only applies to unearned income. For example, if your child inherits a 401(k) or traditional IRA, the income they get from it is subject to the Kiddie Tax.
Your child’s wages are considered earned income and are therefore not subject to this tax.
Pro: Retirement Savings
Even though you’re hiring your child, it’s never too early for them to start thinking about retirement. The sooner they start saving, the more time they leave for compounding returns to grow their savings.
If you pay your children, they can put money into a retirement account. Assuming they don’t earn enough to pay any income tax, they could place their earnings into a Roth IRA and pay no tax on the income or the withdrawals from the account.
Imagine you hire your ten-year-old to do some basic tasks around the company, such as stocking shelves. You pay them enough to max out their Roth IRA for the year by depositing $6,500 into the account. Assuming a 7% return, they could wind up with more than $250,000, even if they never save another penny. Just keep in mind, that this growth isn’t guarenteed and is based on market performance.
You don’t have to hire your children to set them up for retirement early. If they work a job outside of your business, they can still contribute a Roth IRA and get the benefits of saving early.
Con: Complex rules with room for error
When it comes to hiring your children, the rules aren’t straight forward. First, you need to stay on top of child labor laws, federally, in your state, and in your industry, as some types of work isn’t suitable for children below a certain age.
You’ll also need to ensure that you pay your child a resonable wage and have your child perform legitament work. The legitament work your child does will need to be documented. The Fair Labor Standards Act (FLSA) monitors children who are employed to ensure they aren’t working in unsafe conditions or performing tasks that impact their education.
In the event of an audit, the FLSA and IRS could scrutinize the type of work your child performs and deem it as unlegitament. If this happens, your child will be disqualified as an employee and you’ll have to refile your tax returns without the tax savings you received from your employing your child. You’ll then need to pay back those savings, plus interest and penalties.
Con: Increases risk of audit
Even if you’re not an S Corp or C Corp owner, hiring your children can still increase your risk of an audit. Hiring children is considered a widely abused tactic to avoid paying taxes and the IRS is watching out for this.
The wide spread abuse of this tactic, paired with the complex rules, leave business owners vulnerable to an audit. Not only will you have to defend and substaniate the legitment work and wage of your child, but you also open yourself up for an audit in other areas of business and personal tax structure.
If other areas of your business aren’t following IRS guidelines (or you don’t have the proper documentation), you risk more than just paying back the savings you gained from hiring your children.
When Shouldn’t You Hire Your Children?
If you answer yes to the following questions, you should reconsider before hiring your kids.
- Do you run an S Corp or C Corp?
- Is your child too young to do real work for your business?
- Do you operate in an industry that is unsafe or designated by the federal or local government as unsuitable for children to work in, even children of the business owners?
- Are you relying on need-based aid for your child to go to college? Schools expect kids to put more of their assets toward tuition than parents.
What to Do and Not Do When Hiring Your Kids
If you choose to hire your children, it’s essential that you follow all of the rules and regulations and keep things above board. Treating them like actual employees and dealing with all the paperwork is better than keeping things informal and possibly getting into trouble.
- Make sure your child does legitimate work: You can’t hire and pay your kid not to do any work. Make sure they have defined tasks that they complete. Having an employment contract outlining their responsibilities is a good idea.
- Pay reasonable wages: Paying your child a real wage is also essential. Giving your kid $13,000 for an hour of helping with your company’s social media is a blatant attempt to subvert the tax code and will likely get you in trouble with the IRS. Paying slightly more than minimum wage for manual labor is more reasonable.
- Follow general and child labor laws: Make sure you don’t place your child in a dangerous job that isn’t legal in your state. For example, Massachusetts prohibits those under 16 from certain tasks, like cooking on open flames, and limits working hours during the school year.
- Keep payroll records: As with any employee, keep a good record of your child’s earnings and payroll.
- Count personal payments as a business expense: If you give your kid money on a personal basis, like for doing house chores or as a reward for good grades, don’t count it as business wages.
- Pay your kid in cash: Pay by check or direct deposit into an online bank account when possible. This creates a clear paper trail of your child’s earnings.
Consider What’s Best for You
For many small business owners, hiring their children can sounds like an appealing way to bring their kids into the family business. However, there are risks involved and it’s important to consider the advantages and disadvantages to ensure that it will benefit you, your company, and most importantly, your child.
TJ Porter is a freelance writer based in Boston, Massachusetts. He began covering finance while earning a degree in business at Northeastern University in Boston, Massachusetts and enjoys writing about credit, investing, real estate topics. When he’s not writing, TJ enjoys cooking, sports, and games of the video and board varieties. You can contact him at find more of his work at TJPorterWriting.com