Can I Pay My Child a Salary From My Business?

Paying a child a salary from a business can be a legitimate and advantageous practice for business owners. It allows for the transfer of income within a family unit, potentially leading to tax efficiencies and providing children with valuable work experience and financial literacy. This approach involves specific requirements and considerations to ensure compliance with tax regulations.

Conditions for Valid Employment

For a child’s salary to be a legitimate and tax-deductible business expense, specific requirements must be met. The Internal Revenue Service (IRS) scrutinizes family employment relationships to ensure they are genuine. Establishing a bona fide employer-employee relationship is essential. This means the child must be a legitimate employee, not simply receiving an allowance or gift disguised as wages.

The child must perform actual services that are necessary and ordinary for the business. Examples of qualifying work include general office assistance, website maintenance, cleaning the business premises, or managing social media accounts. The work performed must be appropriate for the child’s age and capabilities; for instance, a young child would not credibly perform complex accounting tasks.

The compensation paid to the child must be reasonable for the services rendered. The salary should be comparable to what an unrelated individual would be paid for similar work in the open market. Paying an excessive amount can lead to challenges from tax authorities, potentially resulting in the disallowance of the deduction. Comparing the proposed wage to industry standards or rates for similar positions can help establish reasonableness.

Maintaining thorough documentation and record-keeping is important to substantiate the employment arrangement. This includes having a clear job description outlining the child’s duties, maintaining time sheets or other records of hours worked, and conducting performance reviews. Proof of payment, such as pay stubs or bank transfer records, is also necessary to demonstrate that wages were actually paid.

Tax Implications for Business and Child

Once the conditions for valid employment are met, specific tax consequences and advantages arise for both the business and the child. For the business, the salary paid to the child is deductible as a business expense. This deduction reduces the business’s taxable income, which lowers the overall tax liability for the business owner. This strategy effectively shifts income from the business owner’s potentially higher tax bracket to the child’s typically lower tax bracket.

For the child, the salary received is considered earned income. Children can use their standard deduction to offset this income, potentially resulting in little to no federal income tax liability. For the 2025 tax year, a single filer’s standard deduction is $15,000. This means a child can earn up to this amount without owing federal income tax.

The “Kiddie Tax” rules, which typically apply to unearned income, generally do not apply to earned income. Earned income, such as wages, is taxed at the child’s own tax rate, not the parent’s higher marginal tax rate. This distinction is important because the Kiddie Tax aims to prevent income shifting of investment earnings, not compensation for legitimate work.

Having earned income also enables the child to contribute to a Roth IRA. Contributions to a Roth IRA are made with after-tax dollars, but qualified distributions in retirement are tax-free. For 2025, the maximum annual contribution to a Roth IRA is $7,000, or the total of the child’s earned income for the year, whichever is less. This allows children to begin saving for retirement early, taking advantage of long-term tax-free growth.

Administering Payroll and Taxes

The practical steps for administering payroll and fulfilling tax obligations for a child employee are similar to those for any other employee. Businesses generally need an Employer Identification Number (EIN) to set up payroll, especially if they have employees or operate as a corporation or partnership. An EIN is acquired free of charge from the IRS by completing Form SS-4.

Federal income tax withholding is generally required for all wages paid, regardless of the child’s age or the business structure. The child should complete Form W-4, Employee’s Withholding Certificate, to provide the necessary information for accurate withholding. This form helps determine the correct amount of federal income tax to be withheld from each paycheck.

Rules regarding Social Security and Medicare taxes, known as FICA taxes, vary depending on the business structure and the child’s age. For a child under 18 years of age employed by a parent’s sole proprietorship or a partnership where each partner is a parent of the child, wages are exempt from FICA taxes. This exemption applies to both the employer’s and employee’s share of these taxes. However, this exemption does not apply if the business is a corporation, even if controlled by the child’s parent.

Similarly, Federal Unemployment Tax (FUTA) requirements have specific exemptions for family employment. Payments to a child under 21 years of age employed by a parent’s sole proprietorship or a partnership where each partner is a parent are exempt from FUTA taxes. This exemption also does not apply to corporations. At year-end, a Form W-2, Wage and Tax Statement, must be issued to the child, reporting their total wages and any federal income tax withheld. Maintaining detailed payroll records, including pay stubs and documentation of tax deposits, is important for compliance and verification.

Age and Business Structure Considerations

The child’s age and the legal structure of the parent’s business significantly impact payroll tax rules, particularly concerning FICA and FUTA taxes. For FICA taxes (Social Security and Medicare), wages paid to a child are exempt only if the child is under 18 years of age. Once the child turns 18, their wages become subject to FICA taxes, similar to any other employee.

For FUTA taxes, a more liberal exemption applies; wages paid to a child are exempt until they reach 21 years of age. This means that even after a child turns 18 and FICA taxes apply, FUTA taxes may still be exempt for several more years.

The business structure determines whether these family employment exemptions apply. The FICA and FUTA exemptions for employing a child are generally applicable only to sole proprietorships and partnerships where all partners are parents of the child.

Conversely, these specific family employment exemptions do not apply to corporations, including S corporations and C corporations. Even if the corporation is closely held and entirely owned by the child’s parents, wages paid to a child employee are subject to FICA and FUTA taxes regardless of the child’s age. Businesses structured as corporations must withhold and pay all applicable payroll taxes for their child employees.