How to Pay Your Child From Your Business

Paying your child from your business can be a beneficial financial strategy for family-owned businesses. This approach involves treating your child as a legitimate employee, allowing for potential tax advantages and providing valuable work experience. To ensure compliance and realize these benefits, it is important to understand and adhere to specific regulations set forth by tax authorities.

Understanding the Benefits and Core Requirements

Employing your child can offer notable tax advantages for your business and for the child. Wages paid to your child can be deducted as a business expense, reducing your overall taxable income. For the child, their earned income is subject to their own tax bracket, and they can utilize the standard deduction, potentially reducing their personal income tax liability. For example, in 2024, a single filer can earn up to $14,600 without owing federal income tax, provided this is their only income.

Payroll tax benefits relate to FICA (Social Security and Medicare) and FUTA (Federal Unemployment Tax Act). If your business is a sole proprietorship or a partnership where each partner is a parent of the child, payments to a child under age 18 are generally not subject to Social Security and Medicare taxes. Wages paid to a child under age 21 in such business structures are typically exempt from FUTA. However, these exemptions generally do not apply if your business is a corporation, or a partnership where not all partners are parents of the child; in these cases, FICA and FUTA taxes usually apply regardless of the child’s age. All wages paid to a child, regardless of age or business structure, are subject to federal income tax withholding.

For payments to be legitimate and deductible, core requirements must be met. The employment must be “bona fide,” meaning the child must genuinely perform necessary work for the business, similar to any other employee. Tasks assigned should be ordinary and necessary for the business’s operation, not personal chores, and appropriate for the child’s age and capabilities. For instance, a kindergartner cannot credibly manage the business’s books, but a teenager could assist with administrative tasks or social media.

Compensation paid to the child must be reasonable for the services performed. The wage should be comparable to what an unrelated individual would earn for similar work, considering market rates, the child’s experience, and hours worked. Paying an exaggerated amount to gain a larger tax deduction could raise IRS scrutiny. Documenting the work performed and hours spent helps substantiate the reasonableness of the compensation.

Formally Establishing the Employment Relationship

To establish a legitimate employment relationship, treat your child like any other employee, starting with a clear job description. This document should outline the child’s specific duties, responsibilities, and expected work hours. A well-defined job description supports bona fide employment by demonstrating the work is real and contributes to the business.

Essential documents must be completed to formally onboard your child. The child must fill out a Form W-4, Employee’s Withholding Certificate, which provides your business with information to determine the correct amount of federal income tax to withhold from their wages. This form also accounts for filing status, multiple jobs, and dependents, which influence withholding calculations.

Another critical document is Form I-9, Employment Eligibility Verification, which verifies the child’s identity and eligibility to work in the United States. Acceptable documents for Form I-9 include a U.S. passport, a Permanent Resident Card, or a combination of documents such as a Social Security card and a state-issued driver’s license or identification card. All documents presented must be unexpired.

If your business is a sole proprietorship and this is your first time hiring employees, obtain an Employer Identification Number (EIN) from the IRS. An EIN is a unique nine-digit number used for tax purposes. While sole proprietors without employees are not always required to have an EIN, it becomes necessary when hiring staff. The application for an EIN is free and can be completed online through the IRS website, or by mail or fax using Form SS-4. Once all documentation is in order, the child should be set up within the business’s payroll system, whether managed manually or through a professional payroll service.

Managing Ongoing Payroll and Tax Obligations

Consistent payroll processing is necessary when employing your child. This involves regularly tracking hours worked, often through timesheets or work logs, and accurately calculating gross pay. Maintaining a regular pay schedule, such as weekly, bi-weekly, or monthly, reinforces the legitimacy of the employment relationship.

Your business is responsible for various tax withholding and deposit obligations. Federal income tax must be withheld from your child’s wages based on their Form W-4. Federal tax deposits for withheld income taxes and FICA (if applicable) must be made regularly to the IRS, either monthly or semi-weekly, depending on your business’s total tax liability. Monthly depositors typically remit taxes by the 15th day of the following month, while semi-weekly depositors have specific deadlines based on the payday.

Several forms must be filed. Annually, your business must issue a Form W-2, Wage and Tax Statement, to your child, reporting their wages and any taxes withheld. Quarterly, Form 941, Employer’s Quarterly Federal Tax Return, is used to report wages paid, federal income tax withheld, and FICA taxes. Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, is filed annually to report FUTA taxes. State income tax withholding and state unemployment insurance obligations also apply, which vary by state and require state-specific filings.

Maintaining Essential Records

Maintaining comprehensive and accurate records is crucial for demonstrating compliance with tax laws and employment regulations. These records serve as evidence of the legitimate employment relationship, work performed, and compensation paid, which can be important in the event of an IRS or state audit. Proper documentation helps support the deductibility of wages and the applicability of any tax exemptions.

Key records to keep include detailed job descriptions outlining the child’s duties and responsibilities. Timesheets or work logs documenting hours worked are also important. Proof of payment, such as bank statements, copies of checks, or direct deposit confirmations, should be retained to verify wages were actually paid.

Comprehensive payroll records, detailing gross pay, deductions, and net pay for each pay period, are necessary. Copies of all filed federal and state tax forms, including Forms W-4, I-9, W-2, 941, and 940, should be kept on file. These documents collectively demonstrate that your business met its obligations for tax withholding, reporting, and payment.

Tax records should generally be retained for a minimum of three years from the date the tax return was filed or the tax was paid, whichever is later. For employment tax records, it is recommended to keep them for at least four years after the tax becomes due or is paid. Keeping these records organized and accessible is a proactive measure that can simplify future tax filings and provide a strong defense in case of inquiry.