How Much Can I Pay My Child Tax Free?

Parents operating a business can employ their children, which may offer tax advantages for both the business and the child. This arrangement can lead to deductions for the business, reducing the parents’ taxable income, while allowing the child to earn income under specific tax rules. Understanding these regulations ensures compliance and maximizes tax efficiency. This guide clarifies the parameters for legitimately paying children and the associated tax implications.

Income Tax Exemptions for Children

A child’s earned income can be received free from federal income tax up to a certain threshold. This is due to the standard deduction, which applies to dependents. For the 2024 tax year, a dependent child’s standard deduction is limited to the greater of $1,300 or their earned income plus $450, up to a maximum of $14,600 for single filers. If a child’s earned income does not exceed this standard deduction, they will not owe federal income tax on those wages.

This tax-free treatment applies to earned income from legitimate work performed for the business. The distinction between earned income (wages, salaries, or professional fees) and unearned income (such as interest, dividends, or capital gains) is important, as different tax rules apply to unearned income.

For example, if a child earns $8,000 in wages from a parent’s business in 2024, their standard deduction would be $8,450 ($8,000 plus $450), making their federal taxable income $0. If their earnings were $1,500, their standard deduction would be $1,500. This income tax exemption applies at the federal level, though state income tax rules may vary.

Payroll Tax Exemptions for Children

The application of payroll taxes, specifically Social Security and Medicare taxes (FICA taxes), and federal unemployment taxes (FUTA), on a child’s wages depends on the legal structure of the parent’s business. Different rules apply based on whether the business is a sole proprietorship, a partnership, or a corporation.

If the business is a sole proprietorship or a partnership where the only partners are the child’s parents, wages paid to a child under 18 are exempt from FICA taxes. Wages paid to a child under 21 are also exempt from FUTA taxes under these business structures.

However, if the business is incorporated, such as a C-corporation or an S-corporation, these FICA and FUTA exemptions generally do not apply. The child’s wages are subject to Social Security, Medicare, and FUTA taxes, regardless of their age, just like any other employee.

If a child is engaged as an independent contractor rather than an employee, different rules apply. Independent contractors are subject to self-employment tax, which covers Social Security and Medicare taxes, once their net earnings reach $400 or more. This tax is 15.3% of net earnings, consisting of 12.4% for Social Security and 2.9% for Medicare, and the individual is responsible for paying both the employer and employee portions.

Establishing Legitimate Employment for Your Child

To ensure payments to a child are recognized as legitimate business expenses by tax authorities, certain criteria must be met. The Internal Revenue Service (IRS) scrutinizes these arrangements to prevent them from being disguised gifts rather than actual compensation for services. Adhering to these guidelines helps ensure the deductibility of wages and avoids potential issues during an audit.

The child must perform real and necessary services for the business. The work should contribute directly to business operations and be something an unrelated employee would typically do. Examples include office work, website maintenance, cleaning, or assisting with marketing. The work performed should also be appropriate for the child’s age and capabilities; for instance, paying a young child for complex accounting tasks would likely be unreasonable.

Compensation paid to the child must be reasonable for the work performed. The wage rate should be comparable to what an unrelated individual would be paid for similar work in the industry. Paying an excessive amount solely because the employee is a family member could lead to the IRS disallowing the deduction for the unreasonable portion of the wages. Clear documentation is necessary to support the employment and payments.

Comprehensive records should be kept to support the employment arrangement. These records include detailed job descriptions, timesheets or logs documenting hours worked, and evidence of consistent payments, such as pay stubs or bank transfer records. Creating an employment agreement can also provide further evidence of a formal employment relationship.

Tax Filing and Record Keeping

After a child has worked and received payments, specific procedural steps are required for both the parent’s business and the child regarding tax filing and record keeping. These actions ensure proper reporting to tax authorities and maintain the legitimacy of the employment arrangement.

The parent’s business is responsible for deducting the wages paid to the child as a business expense. If the child is treated as an employee, the business should issue a Form W-2, Wage and Tax Statement, to the child. This is required even if no income tax was withheld, as W-2s report earned income. If the child is an independent contractor paid $600 or more in a calendar year, the business must issue a Form 1099-NEC, Nonemployee Compensation. The threshold for issuing a Form 1099-NEC is $600 for 2025, and this amount is set to increase to $2,000 for tax year 2026.

The child may also have responsibilities for filing their own tax return. Even if a child’s earned income is below the standard deduction and no federal income tax is owed, filing a return might still be beneficial. This allows the child to claim a refund for any income tax withheld from their wages. If the child’s earned income exceeds their applicable standard deduction, they are required to file a federal income tax return.

Maintaining thorough and accurate records is important for both the business and the child. This includes all documentation mentioned previously, such as job descriptions, timesheets, payment records, and copies of any tax forms issued (W-2s or 1099-NECs). These records serve as crucial evidence to substantiate the legitimacy of the employment and the claimed deductions in the event of a tax inquiry or audit. Consistent and comprehensive record keeping supports the tax positions taken by both the business and the child.