A common tax strategy for business owners is to pay your children through your company. If done correctly, you get the tax deduction while your children will not pay any tax.
While this is a great strategy, it is often not done in a tax efficient manner. There are a couple reasons for this.
In this post, will explain the rules of employing your children through your business. We will also point out the #1 strategy to make this the most tax efficient. Let’s get started!
Table of contents
Some Background
You can pay your child up to $15k without them needing to file a federal tax return. However, it’s important to follow one key guideline: pay your child as an employee rather than as an independent contractor. If you classify them as an independent contractor, they will be required to file a tax return and pay self-employment tax.
You can legally pay your children for work they do in your business, which offers a significant tax advantage. By doing this, you can transfer income from your higher tax bracket to theirs. Since their tax bracket is likely to be 0%, this can result in substantial tax savings for you.
When considering work opportunities for your children, consider options such as social media management, blogging, video production, and computer-related tasks. These roles can help them develop valuable skills, and you can offer them a higher wage compared to basic tasks like emptying the trash in your home office.
Business Structure
If you have a new or evolving business, you’ve likely considered what type of business structure you should choose. This discussion focuses on active income, meaning income generated from the sale of products and/or services to external customers, rather than real estate income.
Typically, the decision comes down to two options: a single-member LLC that does not make a tax election (also known as a disregarded entity or DRE) or a single-member LLC that elects to be taxed as an S Corporation.
Both options have their pros and cons, but let’s explore a strategy that combines the advantages of both structures.
For instance, you could operate a profitable S Corporation and have two children who provide legitimate work for the business. If both children are under the age of 18, they can be paid a salary that is exempt from Social Security, Medicare, and unemployment taxes, as long as the business is set up correctly.
An S Corporation Might not be the Right Structure
A Sole Proprietorship (filed as Schedule C on your Form 1040) permits minor children under the age of 18 to be employed without being subject to Social Security, Medicare, and unemployment taxes. This means that no taxes need to be withheld from their paychecks. As the employer, you are not required to pay your share of payroll taxes.
However, if you operate an S Corporation you do not receive the same tax exemption for employed minor children.
To address this, you could establish a Sole Proprietorship, which can either be an unregistered entity or a single-member LLC taxed as a disregarded entity (DRE). The S Corporation made a payment to the DRE, which served as a deduction for the S Corporation and income for the Sole Proprietorship. The Sole Proprietorship was created to provide the services rendered by the children. You should maintain a paper trail by generating invoices from the Sole Proprietorship to the S Corporation.
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The Sole Proprietorship can subsequently pay the children through a regular payroll system, thereby avoiding payroll taxes. After paying the children, there can be no taxable income remaining in the Sole Proprietorship.
The income received by the children will not be taxable, nor will it be required to be reported by them. In 2025, the children can earn up to $15,000 in total without incurring federal taxes. It is important to note that while most states follow similar rules, you should check the regulations specific to your state.
Rules for Employing Children
When it comes to paying your kids, there are three important rules to follow:
- Pay a Fair Wage: Ensure that the wage you pay is reasonable for the work they are doing. For example, it’s not appropriate to pay your 8-year-old $100 an hour to take out the trash.
- Provide a Written Job Description: Clearly outline the tasks that your child is responsible for in a written job description.
- Track Hours Worked: Keep a record of the hours your child has worked to ensure accurate payment.
Other Deductions When Employing Children
Once your child becomes an employee, you can provide them with various benefits. This might include purchasing a cell phone for your child, which can be used for business purposes, and covering the cost of the cell phone plan. Tax Savings Potential: $400
If your child enrolls in a class, workshop, or summer camp that enhances their job skills, the expenses can be deducted. This is a way to write off a portion of their college education. Tax Savings Potential: $8,000
Any electronics you purchase for your child’s work are also deductible. Tax Savings Potential: $1,000
Additionally, your child can fund a Roth IRA and write off expenses for business meals and travel.
Is a Cash Balance or Defined Benefit Plan Right For You?
Final Thoughts
Selecting the appropriate business structure is crucial for safeguarding your assets and minimizing your tax obligations. It significantly contributes to an efficient tax-saving strategy.
If you operate a Sole Proprietorship (Schedule C) and pay your minor child for the work they perform in your business, you are not required to pay Social Security or Medicare taxes. This tax advantage is only applicable if you employ your child through a Schedule C business.