Tax Rules for Employing Your Minor Child

Employing your minor child can provide valuable work experience for them and tax advantages for the family business. This arrangement requires treating your child as a legitimate employee and adhering to specific tax laws and documentation standards. When structured correctly, a business owner can deduct the child’s wages as a business expense, which lowers the business’s overall taxable income.

Tax Implications of Hiring a Minor Child

When a business owner hires their child, the wages paid are deductible as a business expense, which reduces the business’s taxable profit. A primary tax benefit relates to federal payroll taxes. Payments made to a child under 18 are not subject to Social Security and Medicare (FICA) taxes, which eliminates the 7.65% employer portion of these taxes on the child’s wages.

A separate exemption applies to the Federal Unemployment Tax Act (FUTA), as wages paid to a child under 21 are not subject to FUTA tax. These exemptions from FICA and FUTA taxes have distinct age limits. The FICA exemption ends when the child turns 18, and the FUTA exemption continues until the child reaches 21.

While these payroll tax exemptions apply, the child’s wages are still subject to federal income tax withholding. The child can use their own standard deduction to reduce or eliminate their income tax liability. For 2024, the standard deduction for a single individual is $14,600, meaning a child can earn up to this amount without owing federal income tax if they have no other income. If the child’s total income falls below this threshold, any income tax withheld during the year can be refunded after they file their own tax return.

How Business Structure Affects Employment Rules

The availability of payroll tax exemptions for employing a minor child is directly dependent on the legal structure of the business. The most favorable structure for these benefits is a sole proprietorship or a single-member limited liability company (LLC) that is treated as a disregarded entity for tax purposes. In these cases, the FICA and FUTA tax exemptions apply fully.

Sole Proprietorships and Single-Member LLCs

For a business operating as a sole proprietorship, the owner and the business are considered a single entity for tax purposes. This structure allows for the most straightforward application of the tax exemptions. When a parent who is a sole proprietor employs their child, the previously discussed FICA and FUTA exemptions apply directly to the child’s wages.

Partnerships

The rules for partnerships are more specific. The FICA and FUTA tax exemptions are available only if the partnership is owned exclusively by the child’s parents. If the partnership includes any non-parent partners, such as an uncle or unrelated business associate, the exemptions are voided. In that scenario, the child’s wages become subject to all standard payroll taxes.

Corporations (S-Corps and C-Corps)

When a business is structured as a corporation, whether an S-Corporation or a C-Corporation, the payroll tax exemptions for hiring a minor child do not apply. The law views a corporation as a separate legal entity from its owners. Consequently, a child employed by the family’s corporation is treated the same as any non-family employee, and their wages are subject to FICA and FUTA taxes, regardless of the child’s age.

Required Hiring Documentation and Payroll Practices

To legitimately employ a minor child and benefit from the associated tax rules, the employment arrangement must be formalized with proper documentation. The work performed by the child must constitute a real job with genuine responsibilities that are necessary for the business. Paying a child for personal chores or assigning tasks that are not age-appropriate would not be considered legitimate employment by the IRS.

To substantiate the employment relationship, a business owner should follow several practices:

• Provide reasonable compensation that aligns with the prevailing wage for the work being performed. To determine a fair wage, a business owner can research what they might pay a non-relative for the same job.
• Maintain a formal job description that outlines the child’s duties and responsibilities, as this is a recommended practice.
• Complete standard employment forms. The child must complete Form I-9, Employment Eligibility Verification, and Form W-4, Employee’s Withholding Certificate.
• Keep meticulous records to prove the child is a bona fide employee. This includes detailed timesheets tracking hours worked and proof of payment, such as copies of payroll checks or records of direct bank transfers.

Establishing a Retirement Account for Your Child

The wages paid to an employed minor child are considered earned income, which creates an opportunity for long-term financial planning. This earned income makes the child eligible to contribute to an Individual Retirement Arrangement (IRA). Opening a retirement account for a child can be a tool for teaching financial literacy and building wealth over a very long time horizon.

A Roth IRA is often an advantageous choice for a minor. Contributions to a Roth IRA are made with after-tax dollars, meaning the child pays tax on the income now. The benefit is that the investments within the account can grow tax-free, and qualified withdrawals in retirement are also tax-free. Given that a child is likely in a very low or even zero percent tax bracket, paying minimal tax on contributions is a small price for decades of tax-free growth.

The amount that can be contributed to an IRA each year is subject to an annual limit set by the IRS. For 2024, the maximum contribution is the lesser of the child’s total earned income for the year or $7,000. This means if a child earns $4,000 from their job, they can contribute up to $4,000 to their IRA for that year.