Hiring Your Child

Hiring Your Child: Legal Tax-Saving Scenario

A family-owned business paying a child for legitimate work is a straightforward and long-standing tax strategy. It is also one that requires genuine compliance with employment law to be defensible—the IRS examines these arrangements, particularly when they produce suspiciously large deductions for suspiciously small contributions. Done correctly, it shifts income from a high-tax parent to a zero- or low-tax child, creates a Roth IRA funding opportunity, and builds early financial literacy. Done incorrectly, it triggers penalties, disallowed deductions, and in some cases employment tax liability.

THE TAX ECONOMICS

When a sole proprietor (or partnership of spouses) pays their minor child for legitimate work, several tax advantages converge:

Business deduction for the parent: Wages paid to the child are a deductible business expense on Schedule C, reducing the parent's net self-employment income—which reduces both income tax and self-employment tax. At a combined effective rate of 30% (22% income tax + SE tax impact), a $6,000 wage deduction saves approximately $1,800.

Zero or low income tax for the child: The standard deduction in 2024 is $14,600 for a single filer. A child's earned income up to $14,600 is completely sheltered by the standard deduction—they owe no federal income tax at all. Income above $14,600 would be taxed at the child's rate, typically 10% for the first bracket.

No FICA taxes in qualifying situations: For children under age 18 working for a parent's sole proprietorship or partnership (where both partners are the child's parents), FICA taxes—Social Security and Medicare—are not required to be withheld or matched. This is an exception under IRC Section 3121(b)(3) that eliminates both the employee and employer portions of FICA. No FICA on $6,000 in wages means the parent doesn't pay the employer's 7.65% ($459) and the child doesn't have 7.65% withheld from their paycheck.

Roth IRA funding with the child's wages: A child with earned income can contribute to a Roth IRA up to the lesser of their earned income or the annual limit ($7,000 in 2024). Wages from a family business constitute earned income. A child earning $7,000 in wages can contribute the full $7,000 to a Roth IRA. That contribution, if invested at age 14 and left untouched for 50 years at 7% growth, grows to approximately $206,000—tax-free.

The combined effect: the parent deducts $7,000, saving $2,100 in taxes. The child pays no income tax. The $7,000 goes into a Roth IRA. The net cost of $7,000 into a Roth IRA is $4,900 to the family after the deduction—effectively a 30% discount on a Roth IRA contribution.

THE REQUIREMENTS THAT MAKE IT DEFENSIBLE

This strategy works legally only when the employment is genuine. The IRS applies a "reasonable and ordinary" standard to family employment arrangements. Every element of the employment relationship must reflect how you would treat an unrelated employee performing the same work.

The work must be real and age-appropriate. A 10-year-old can legitimately:

- Stuff and address envelopes for a mailing - Help with social media posting or content creation (with guidance)

- Assist with inventory tasks in a retail or product business

- Clean or maintain business premises - Help with photography, event setup, or other hands-on tasks relevant to the business

- Model or appear in business advertising (with proper documentation)

- File, organize, or perform clerical tasks appropriate for their age

A 10-year-old cannot legitimately be your "chief marketing officer," serve as a licensed professional, or perform work that would be illegal for a child to do.

The wage must be reasonable. Pay the child what you would pay an unrelated person for the same work—not more, not less. Paying a child $75/hour for filing documents, when a comparable service would cost $15/hour, is not defensible. The IRS looks at the tasks performed and the compensation relative to market rates.

The hours and work must be documented. Maintain records of what work was performed, when, and for how long. A simple time log—even a handwritten record of dates, tasks, and hours—is the same substantiation required for any employee. If the child works three hours per week during the summer and you're claiming $8,000 in wages, the math won't hold up.

Payroll must be processed properly. Issue actual paychecks, or documented transfers to the child's bank account. Wages cannot be cash-in-hand with no record. If the employment relationship doesn't look like employment—with a paper trail consistent with an employment relationship—it isn't defensible as one.

Issue a W-2 at year-end. A child employed by a sole proprietor receives a W-2 for wages paid. For amounts below the federal income tax withholding threshold (typically wages under $14,600 for a child with no other income), no federal income tax withholding is required—the child will file a return showing zero tax. But the W-2 itself is the documentation of the employment relationship.

THE FICA EXCEPTION: WHICH BUSINESS STRUCTURES QUALIFY

The exemption from FICA taxes for minor children applies specifically to:

- Sole proprietorships (one parent as the business owner)

- Partnerships where both partners are the child's parents

It does not apply to: - Corporations (including S corporations) - Partnerships where one partner is not the child's parent

If your business is an S corporation or a C corporation, FICA taxes apply to wages paid to a child employee just as they would to any other employee. The deduction and income-shifting benefits still exist—only the FICA exemption is unavailable in corporate structures.

For self-employed workers operating as sole proprietors, the FICA exemption adds approximately $918 in savings on a $6,000 wage (7.65% employer FICA + the equivalent employee FICA that would have been withheld), on top of the income tax deduction.

AGE-BASED CONSIDERATIONS

Children under 7: The IRS has successfully challenged child employment arrangements for very young children on the basis that the work isn't credibly performed. While there is no explicit minimum age in the statute, documentation must be very solid and the work genuinely appropriate. Modeling, certain creative tasks, and basic physical help that a young child can actually do are defensible; professional or cognitive work is not.

Children 7 to 12: Clearly can perform clerical, creative, and physical tasks. Documentation and reasonable compensation are key. These arrangements are well-established in case law when the work is genuine.

Children 13 to 17: Most types of age-appropriate employment are defensible. The FICA exemption applies through age 17; at 18, the exemption ends and FICA taxes apply.

Children 18 and older: No FICA exemption. All standard employment taxes apply. The income-shifting benefit (deduction for parent, lower rate for child) still exists if the child is in a lower bracket.

THE ROTH IRA MECHANICS

Opening a custodial Roth IRA for a child requires a brokerage that offers them—Fidelity and Charles Schwab both offer Roth IRAs for minors. A parent or guardian manages the account until the child reaches the age of majority, at which point the child takes control.

The child's contribution cannot exceed their earned income for the year, and it cannot exceed the annual Roth IRA limit ($7,000 in 2024). Wages from the family business qualify. The Roth IRA can be funded from either the child's wages or from the parent's funds—there is no requirement that the child personally deposit their own paycheck, only that the child has at least as much earned income as the contribution amount.

Investing early Roth IRA contributions in a total stock market index fund takes five minutes and requires no ongoing management decisions. The compounding from that early start—even small amounts invested at age 12 or 14—produces dramatically larger retirement balances than starting contributions in early adulthood.

WHAT TO AVOID

Paying wages the child doesn't actually earn: The deduction is only defensible if the work was performed. Paying a child $10,000 while they were in school full-time with no documented business activity is not a legitimate deduction—it's a tax fraud exposure.

Circular transactions: Paying wages with one hand and taking the money back with the other (through gifts, family spending, or repayment to parents) undermines the economic reality of the employment. The child's wages should be the child's money.

Not filing the child's tax return: Even if the child owes no tax, a W-2 in the child's name may create a filing obligation. The child's return also establishes earned income for the Roth IRA contribution—file it.

Hiring your child is not a gray-area strategy. It is a straightforward application of the tax code that has been used by family businesses for generations, upheld in Tax Court when substantiated, and disallowed when the work is fictional. The difference is documentation, reasonable compensation, and genuine employment—the same standards that apply to any business deduction.