Understanding W-2 and 1099: A Parent’s Guide
It’s a great strategy to hire your children as legitimate employees in your business. In fact, the higher the taxes you have to pay, the more you can save when you hire your children.
When your children work for you in your business, you can deduct their salaries from your business income as business expenses. For children less than 18, they won’t pay Social Security or Medicare taxes.
W-2 or 1099?
It is preferable to pay your child with a W-2. When paid on a W-2, neither you nor your child will be required to pay Social Security or Medicare taxes. Also, you will not have to pay unemployment taxes. If the salary is less than $12,950, there is no need to pay income tax as well.
However, if you pay on a 1099, the child will have to pay self-employment taxes.
If your business is a single-member LLC, it is a “disregarded entity” for the purposes of federal tax. It is only taxed as a sole proprietorship, so you and your child do not pay Social Security and Medicare taxes.
But if you are operating the business as a corporation, then your child will have to pay for Social Security and Medicare.
Taxes on Children’s Income
If the salary you pay your child is more than the standard deduction amount, then they will need to pay tax on that salary. The standard deduction for 2022 is $12,950 for single taxpayers. This means that you can pay your child up to $1,079 per month or $12,950 annually without the need to pay any tax.
However, if the salary is more than $12,950 every year, then they will have to pay tax. The tax rates for 2022 are shown in the table below:
| Income Tax Rate | Single Taxpayers |
| 10% | $0 – $10,275 |
| 12% | $10,276 – $41,775 |
| 22% | $41,776 – $89,075 |
| 24% | $89,076 – $170,050 |
| 32% | $170,051 – $215,950 |
| 35% | $215,951 – $539,900 |
| 37% | over $539,900 |
Always Follow the Rules
The Internal Revenue Service knows about the tax advantages of hiring your child, so they are always looking for taxpayers who abuse this strategy. Once the IRS can prove that your kids are not legitimate employees, they will not be entitled to those deductions and so will pay taxes on the salaries.
Here are three rules you can follow to prevent this from happening:
- Your child must be a legitimate employee
It is important to make sure that your child is a real employee in your business. They can only get paid for actually performing tasks that are necessary for your business. Your child cannot get business deductions on payments for personal services like mowing your home lawn or babysitting their younger siblings. But they can enjoy deductions on payments for yard work on the business property.
The IRS only accepts that kids that are at least seven years old can help with useful work in your business. Keep track of the work your child does and the hours worked. Ensure that the date, work performed, and hours spent are recorded. You can use an app or create a paper timesheet or a spreadsheet.
- The salary must be realistic
To take advantage of the deduction, you have to pay your kids as much as possible. This will allow your kids to hold as much of your business income as possible with very few tax deductions. You cannot, however, pay any amount you want. You have to make sure that you are paying a realistic salary for the services they are carrying out.
Find out the amount that other businesses pay workers that carry out those tasks. You must also prove how much you are paying. To do this, do not pay your child in cash. Instead, pay by direct deposit or check like for other employees. The bank account name where you pay the salary should be that of your child or your spouse.
- You must satisfy all the legal requirements for employers
Make sure that you satisfy all the legal requirements that you would need to meet if you were employing a stranger. You must fill out the IRS Form W-4, the U.S. Citizenship and Immigration Services (USCIS) Form I-9, Employment Eligibility Verification, and the employee’s Social Security number.
You must also have an Employer Identification Number (EIN). If you do not have your number, you can get it on the IRS website or fill out the IRS Form SS-4. You must fill out and file the IRS Form W-2 every year to show how much you are paying your child.
Molen and Associates can help you fill out these forms and determine how much tax to withhold for each child. For more on teaching your children about tax and financials check out our other other blog post ‘Teaching Your Child Financial Literacy.’ For all of your tax and financial needs, call Molen and Associates today at 281-440-6279.
