Paying your children to work in your business is a legitimate tax strategy — not a loophole, not a gray area. The IRS explicitly allows it, and when done correctly, it shifts money from a high tax bracket to a low one (or eliminates tax on it entirely), while teaching your kids something real about work and business. But the rules are specific, and doing it sloppily invites the exact audit you’re trying to avoid.

How the Tax Math Works

When you hire your child and pay them a reasonable wage for real work, several things happen:

The wage is deductible by your business as a business expense, reducing your taxable income at your marginal rate. If you’re in the 32% bracket, $12,000 in wages to your child saves $3,840 in federal income tax on your return.

The wage is taxable income to your child. But children with no other income can earn up to the standard deduction — $14,600 for single filers in 2024 (verify the current year’s amount) — tax-free. So if your child earns $14,000, they owe zero federal income tax. You shifted $14,000 out of your 32% bracket and it becomes tax-free income for your child.

Additional amounts above the standard deduction are taxed at your child’s (typically much lower) marginal rate, not yours.

And if you’re not already using their earnings for college expenses, their Roth IRA contributions are now eligible — contributing earned income into a Roth IRA for a teenager is one of the most powerful wealth-building moves available.

The Payroll Tax Advantage for Sole Proprietors and Partnerships

If your business is a sole proprietorship or a partnership owned entirely by you and your spouse, there’s an additional benefit: wages paid to a child under age 18 are exempt from FICA taxes (Social Security and Medicare). No payroll tax on either side.

This exemption does not apply to:

– S-Corps or C-Corps (even family-owned)

– Partnerships where any partner is not a parent of the child

If your business is an S-Corp, your child’s wages are subject to full FICA on both the employee and employer side — the same as any other employee. The income tax benefit still applies, but you lose the payroll tax exemption. This is an often-overlooked detail when business owners assume the strategy works the same regardless of entity type.

The Rules the IRS Cares About

This is where most people who abuse the strategy get caught. The IRS looks for two things: real work performed and reasonable wages.

Real work: Your child must actually perform legitimate services for the business. Common roles that work well include administrative work, social media management, photography, filing, answering phones, cleaning, warehouse work, or assisting at trade shows or events. The work must be appropriate for the child’s age and capabilities.

Reasonable wages: Pay must be at or near the going rate for the work performed. You can’t pay a 12-year-old $50,000 for answering emails occasionally. Wages must reflect what an unrelated employee in the same role would earn. If you’d pay a high school student $15 per hour to manage your Instagram account for 10 hours a week, that’s your benchmark.

Documentation: Keep timesheets or work logs. Pay through your actual payroll, not cash handouts. Issue a W-2 at year-end. Deposit payroll taxes if required. The paperwork trail is what separates a legitimate employment arrangement from a “family disbursement” that the IRS can disallow.

Setting Up the Arrangement Correctly

Issue a W-2, not a 1099: Employing your child creates an employer-employee relationship. Do not issue a 1099-NEC — that would treat your child as a contractor, incorrectly triggering self-employment tax.

Use payroll, even simple payroll: Paying by check or bank transfer is fine, but it should run through your payroll system with proper withholding (or a withholding exemption if your child’s income is below the filing threshold). Your child should fill out a W-4.

Open a bank account in their name: Deposit the wages into your child’s account. It should be genuinely their money, not money you spend for them with a detour through their name.

File the W-2: Issue the W-2 in January for the prior year. This is a filing requirement regardless of whether your child owes tax.

Frequently Asked Questions

Q: What ages are allowed?

A: There’s no minimum age specified in the tax code. The IRS looks at whether the work is real and the wages are reasonable. A 7-year-old doing a TV commercial for a family business is different from a 7-year-old “consulting.” As a practical matter, most strategies that hold up involve children old enough to perform clearly documented work — typically 10 and older, though younger is possible with legitimate roles.

Q: Can my child contribute their wages to a Roth IRA?

A: Yes. Any earned income makes a child eligible to contribute to a Roth IRA up to the lesser of their earned income or the annual contribution limit (verify the current limit). A child who earns $6,000 can contribute $6,000 to a Roth IRA. Contributions made at age 15 will grow for potentially 50-plus years.

Q: What if my child is in college?

A: The same rules apply for adult children. The payroll tax exemption for children under 18 no longer applies, but the income shifting benefit continues as long as they’re in a lower tax bracket than you.

Q: Can I hire my spouse as well?

A: Yes, with different rules. Hiring a spouse doesn’t provide the payroll tax exemption. Wages to a spouse are subject to full FICA. But it can still make sense for retirement plan contribution purposes or for legitimate work that benefits the business.

Hiring your children is one of the cleanest income-shifting strategies available — and unlike some others, it comes with a side benefit of teaching your kids about employment, money, and your business. Done right, it holds up under any examination. Done sloppily, it’s easy to disallow.

If you’d like to apply this to your situation, the team at Molen & Associates is here to help. Schedule a consultation at molentax.com.