Can You Pay Your Kid 12k a Year Tax-Free?

Employing a child in a family business can be a legitimate strategy for managing finances and fostering a child’s understanding of work. This approach offers potential financial benefits for both the business and the child, provided it strictly adheres to established regulations.

Establishing Legitimate Employment

For employment of a child to be recognized by tax authorities, the work must be bona fide. This means the child must perform actual, necessary, and ordinary services for the business. Examples of acceptable work include administrative tasks, website maintenance, cleaning, or social media management.

The compensation paid to the child must be reasonable for the services performed, comparable to what an unrelated employee would earn for similar work. Excessive wages can be disallowed by tax authorities. Adherence to federal and state child labor laws is also necessary, which dictate minimum age requirements and restrictions on work hours or hazardous occupations.

A true employer-employee relationship must exist, where the business controls the work performed and how it is done, and the child is subject to that control. This relationship ensures the employment represents a genuine contribution to business operations.

Tax Advantages for Your Business

Wages paid to a child who is a legitimate employee are generally considered a deductible business expense. This deduction directly reduces the business’s taxable income, which can lead to a lower overall tax liability for the business owner. Deducting wages is often more advantageous than providing non-deductible allowances from personal funds.

This tax benefit applies to various business structures, including sole proprietorships, partnerships where parents are the only partners, S-corporations, and C-corporations. For unincorporated businesses, wages paid to a child under a certain age may also be exempt from specific payroll taxes. For a sole proprietorship or a partnership where both parents are partners, wages paid to a child under the age of 21 are exempt from Federal Unemployment Tax Act (FUTA) taxes. This FUTA exemption does not apply if the business is incorporated, such as an S-corporation or C-corporation.

Tax Treatment for Your Child

Wages earned by a child from employment are considered earned income. For the 2024 tax year, a single filer’s standard deduction is $14,600. If a child’s earned income does not exceed this amount, they may not owe federal income tax on their wages.

The “Kiddie Tax” rules, which typically apply to unearned income like investment earnings, generally do not apply to a child’s earned income from wages. This distinction is important because it means the child’s wages are taxed at their own, typically lower, tax rate rather than potentially being subject to their parents’ higher marginal tax rate.

For payroll taxes, FICA (Social Security and Medicare) taxes are a significant distinction. For a sole proprietorship or a partnership where both parents are partners, wages paid to a child under the age of 18 are generally exempt from FICA taxes. This FICA exemption does not apply if the business is incorporated, if the child is employed by a partnership that includes non-parent partners, or if the child is over the age limit. Earned income also allows a child to contribute to a Roth IRA, which can grow tax-free, providing a long-term financial benefit.

Necessary Documentation and Reporting

Meticulous record-keeping is necessary to substantiate the legitimacy of a child’s employment and the wages paid. This includes maintaining detailed timesheets or logs of hours worked, clear descriptions of the tasks performed, and records of all wages paid. These records are important for demonstrating compliance in the event of a tax audit.

The child must be treated as a regular employee for payroll purposes. This involves ensuring the business has a tax identification number and processes payroll consistently, whether through direct deposit or checks. The child will need to complete a Form W-4 to provide federal income tax withholding information.

Annually, the business must issue a Form W-2 to the child, reporting their total wages and any taxes withheld, just as it would for any other employee. This W-2 form is then used by the child to file their own individual income tax return. The wages paid to the child will be reported as an expense on the business’s relevant tax forms, such as Schedule C for sole proprietorships.