Can You Pay Your Child a Salary Tax-Free?

Paying a child a salary from a family business offers several advantages beyond simply providing them with income. This approach can serve as a valuable tool for teaching financial responsibility and work ethic from a young age. Beyond these educational benefits, there are also potential financial considerations for the business and the family. Understanding how to properly structure such an arrangement is important to ensure it aligns with established guidelines for employment and tax reporting.

Establishing a Legitimate Employment Relationship

For payments to a child to be recognized as a legitimate salary rather than a gift, the employment relationship must meet specific criteria. The child must perform actual, necessary, and ordinary services for the business. These tasks should be genuine business-related activities that an unrelated individual would otherwise perform. For example, age-appropriate duties could include administrative support, social media management, inventory organization, or cleaning.

The child’s work should be documented, similar to any other employee’s, including a clear job description. Compensation provided to the child must be reasonable for services rendered. This implies pay should align with what an unrelated person would earn for similar work in a comparable role and industry. Excessive compensation could be viewed as a disguised gift or dividend by tax authorities.

The child must be genuinely engaged in the business activities, demonstrating a bona fide employment setup. The focus should be on the substance of the work and the arm’s-length nature of the compensation. Maintaining records that clearly show the child’s involvement and the value of their contributions is important for demonstrating the legitimacy of the employment.

Understanding the Tax Treatment

When a child is legitimately employed by a parent’s business, distinct tax implications arise for both the child and the business. For income tax, the child can utilize their standard deduction to receive a certain amount of earned income free from federal income tax. For the 2025 tax year, a dependent can generally earn up to $15,000 without owing federal income tax, provided this income is earned income and does not exceed the standard deduction amount for a single filer. This allows the child to potentially receive a significant portion of their earnings tax-free at the federal level.

Regarding FICA (Social Security and Medicare) taxes, a specific exemption applies based on the business structure and the child’s age. Wages paid to a child under 18 are generally exempt from Social Security and Medicare taxes if the business is a sole proprietorship or a partnership where each partner is a parent of the child. This exemption does not apply if the business is a corporation (S or C corporation) or a partnership where not all partners are parents. In corporate structures, the child’s wages are subject to FICA taxes regardless of age.

For the parent’s business, the salary paid to the child is considered a deductible business expense. This deduction reduces the business’s taxable income, which can lower the overall tax liability for the business owner. This can create a tax-efficient strategy by shifting income from the parent’s potentially higher tax bracket to the child’s lower or zero tax bracket.

Essential Payroll and Recordkeeping

Proper payroll and recordkeeping are necessary to demonstrate the legitimacy of the employment arrangement and ensure compliance with tax regulations. Maintaining detailed work logs or timesheets that record the hours worked and specific tasks performed provides evidence that the child is actively engaged in the business and earning their wages.

The business will need an Employer Identification Number (EIN) for processing payroll and filing employment taxes. The child, like any other employee, must complete a Form W-4 for income tax withholding. At the end of the year, the business must issue a Form W-2 to the child, reporting their wages, even if no income tax was withheld due to the standard deduction.

Depositing the child’s earnings into a separate bank account in their name is a recommended practice. This helps to clearly distinguish the child’s earned income from parental funds. It also demonstrates that the child has control over their earnings. Adhering to these administrative steps helps maintain compliance and supports the claimed tax benefits in the event of a tax review.