You have kids and want to know if there are any tax breaks besides the child tax credit. Lucky for you there is another way to save money from Uncle Sam, – that’s giving your kids a job. That’s right, hire your kids! The truth is, not only can you hire your kids, the government wants you to hire your kids. The IRS website even says, “One of the advantages of operating your own business is hiring family members”. Of course there are rules when you hire children, and we’re going to help you understand them.
There are different tax breaks for hiring family members, but the IRS has specific family members in mind. The IRS outlines the following three types of family members:
The main focus of this article is children. However, you can read more about the other family members in the IRS link above.
At what age can I hire my children?
Back in 1938, Congress created the Fair Labor Standards Act that lets you know how to legally treat employees. Every few years it is updated and they have a section specifically for hiring children. It’s broken down by age, with different sets of rules:
- Kids that are 13 or under
- Children that are 14 thru 17
- Children older than 17
Kids under 14 are usually not allowed to work, unless they are in motion picture, television, YouTube, influencer, etc. (considered Actor or Model work). There are additional carve outs for odd jobs such newspaper delivery or occasional babysitting, but those are not as relevant in the 21st century.
Children between 14 and 17 can usually work most jobs with some restrictions. They are not allowed to work hazardous jobs, and if your child is 14 or 15, they are limited to the number of hours they can work.
The rules are also different between agricultural and non agricultural jobs. If you want more detail about the differences, here is a link to the Department of Labor website that outlines the specific differences regarding Young Workers.
Tax benefits of LLCs for family members
When you hire your kids, you save on payroll taxes by avoiding both FICA (Social Security / Medicare tax) and FUTA (Federal Unemployment tax). If your business is a single member LLC, sole proprietorship, or husband & wife only owned LLC, you get the biggest tax benefits when hiring your children. To help you understand the potential tax savings we’ve provided an example:
Adam owns Virtue LLC (a single member LLC that he controls 100%). He hires his 15 year old son, Miles, as an employee. He pays Miles $1,000 a month for various types of work (puts him in advertisement ads, provides random gofer office work, etc.). At the end of the year Virtue LLC issues Miles a W-2 for $12,000 without being subject to FICA. Miles’ W-2 will look like this:
Virtue LLC saves taxes the following ways
- Get to deduct the full $12,000 from their LLC as an expense (in a 25% tax bracket that’s $3K in savings)
- They don’t have to pay the employer side of FICA ($918 in savings)
- They also save on FUTA tax ($42)
- Total tax savings for the LLC is $3,960
- Additionally, Miles doesn’t pays his side of FICA either ($918 savings to Miles).
When Miles goes to file his own tax return, he will pay zero income tax since the standard deduction is greater than $12,000. This is a great way to save taxes by hiring your child!
What if my business is a Corporation or S-Corporation?
Unfortunately, if you own a Corporation (or S Corp) you don’t get the same payroll tax benefit. Using the same example above, except now Adam owns Virtue Inc. (not LLC) which is an S-Corporation. He will now have to pay both the employer side of FICA and FUTA, so his tax saves are now only $2,040. Also Miles is going to have to pay another $918 out of the $12,000 for his side of FICA. This will bring the total net family tax savings down to only $1,122. Important to remember, you can still hire your kids through your Corporation, you just won’t save as much tax.
Hiring my child as an independent contractor
Now some of you are wondering, what if I hire my kid as an independent contractor, instead of as an employee? In most cases this probably won’t fly. Remember, to be an independent contractor you will need to show that you do not direct or control your employee (in this case, your child.) That’s going to be hard to prove.
Additionally, there are very little tax benefits from your child being an independent contractor, since they now will have to pay self-employment tax (15.3%) on their income. The only possible upside we see by treating your child as an independent contractor is that your child may be able to fund Traditional or Roth IRAs (if their income is high enough).
IRS audit – child workers
If you’ve checked out the About Us section of this website you are aware that I use to work at the IRS. Working there I have a lot of experience auditing various small businesses. One time I audited a small business in which the owners hired their kids.
It was an S-Corporation in which the owners hired all of their kids as independent contractors for $5,000 each. The kids ages ranged between 2 – 7 years old. Additionally, the owners didn’t take an Officer’s Compensation salary.
Listening to the owners try and explain to me how a 3 year old works as an independent contractor on a construction site was humorous to say the least. It was pretty easy of me to re-classify the payments from the kids to the owners, and make the owners pay the FICA, FUTA, and Tax Withholding at their tax rate (which was around 35%).
Bottom-line, the owners of the S Corporation were extremely sloppy when they decided to hire their kids for their business. They never hired a CPA to ask about the correct way to hire their children to make sure that they were subject to IRS audit risk.
Rule of thumb: please make sure to consult your tax advisor before hiring your kids, you don’t want to be sloppy like these guys and get flagged for audit.