As a business owner, you’re constantly seeking ways to reduce your tax burden and maximize profits. One often-overlooked strategy is to hire your kids and family members to work for your company, which not only provides valuable employment opportunities for your loved ones, but can also offer significant tax advantages for your business.
By integrating your family into your business operations, you can take advantage of lower tax rates and deductions. For instance, you may be able to deduct their salaries from your business income, reducing your taxable profit, and shift income to family members in lower tax brackets, thereby decreasing your overall federal tax liability. Additionally, if your children are under the age of 18, they may be exempt from Social Security and Medicare taxes, further reducing your tax burden.
While hiring your family may not be appropriate for every business, it’s worth considering the potential tax benefits as part of your overall financial strategy. Ensure you comply with all applicable laws and regulations when employing family members, and consult with a tax professional to help determine the best approach for your unique situation.
Here’s everything you need to know about hiring your kids and family in your business.
Tax benefits of hiring family members
Income shifting
When you hire your family members in your business, you can shift income to them. This allows you to redistribute the income among family members potentially in lower tax brackets.
For example:
- Your business income is $100,000, and you’re in a 24% tax bracket.
- You hire a family member and pay them a salary of $40,000.
- That family member is in a 12% tax bracket.
This income shift reduces your own taxable income as well, and the amount of tax paid by the family is now lower than if the entire income was only subject to the 24% tax bracket.
Potential reduction in employment taxes
Hiring family members can also lead to a reduction in employment taxes. For example, when you employ your children in the business, you may be exempt from paying Social Security and Medicare taxes for them up to a certain age (currently 18).
Here’s a table that shows the tax savings when employing your child:
| Age of Child | Wages Paid | Social Security & Medicare Taxes Saved |
|---|---|---|
| Under 18 | $15,000 | $2,295 |
| 18–21 | $15,000 | $708 |
Family tax credits
Utilizing family members in your business can also provide you with access to family tax credits. One example of this is the Child and Dependent Care Tax Credit (CDCTC). If your business offers an on-site child or dependent care facility for your employees, including family members, you may be eligible for this tax credit. The tax credit can be up to 35% of the cost of providing the care benefits, up to a maximum of $3,000 per qualifying individual and $6,000 per family per year.
Tax benefits of hiring Your children
Tax benefits for minors
There are additional tax benefits for hiring your kids before they turn 18. First, their income is tax-free up to the standard deduction amount, which is $13,850 for 2023. Additionally, your kids will be exempt from FICA taxes, such as Social Security and Medicare, since they are working for a parent-owned business.
Setting up a Roth IRA for your kids
Even minors can open and contribute to a Roth IRA through a custodial Roth IRA. As a parent, you can contribute to their Roth IRA up to the amount of their earned income, with a maximum of $6,500 in 2023. This allows them to start compounding their money early, and enjoy tax-free withdrawals in retirement.
Here’s an example of the power of compounding early.
Assuming an 11% average annual interest rate, and maxing out their Roth IRA each year, your child will end up with $21 million more in retirement by starting contributions at age 13 versus age 21. A difference in 8 years results in a $21 million difference in retirement.
Best practices to keep in mind
When hiring your kids and family members in your business, it’s essential to ensure that your practices are both legally compliant and ethically sound. This not only helps maintain your business’s reputation but also prevents potential legal issues and financial penalties.
Maintain fair wages and working conditions
Just like with any other employees, you should provide your family members with competitive wages and reasonable working conditions. Pay them according to their skills, experience, and the value they bring to your business, being mindful of minimum wage laws. You can’t pay your 10-year-old $100,000 a year to answer the phone. The IRS scrutinizes wages paid to family members, so be sure to set their compensation at a fair market rate for the work they perform.
Adhere to labor laws and regulations
As an employer, you must comply with labor laws such as working hours, overtime, and benefits applicable to your child or family member. Ensure that you have the necessary permits, especially when hiring minors, and follow child labor laws pertaining to their age group, hours, and work environment.
Keep accurate records and documentation
It’s important to maintain accurate records and documentation for all employees, including your family members. This includes employing them as official employees, providing written job descriptions, maintaining time records, and properly filing tax forms and withholding requirements, like Form W-2. Maintain separate bank accounts for your child’s income and expenses to demonstrate financial transparency.
Avoid conflicts of interest and nepotism
Although it’s natural to want to help your family members succeed, avoid providing preferential treatment that could compromise the best interests of your business. Ensure that all employees, family and non-family alike, are treated equally in terms of opportunities, promotions, and performance evaluations.
Examples of hiring family
Example #1: Hiring your children
Suppose you own a small business and have two children aged 16 and 18. You hire them to work for you during the summer for a total of 12 weeks, paying each of them $5,000. As a result, you can deduct $10,000 in wages from your business income, reducing your taxable income by that amount. Additionally, your children will not have to pay any federal income tax on their earnings because they are below the standard deduction threshold.
Example #2: Hiring your spouse
If you hire your spouse to work for your business, you can take advantage of several tax benefits. For example, you can deduct the cost of your spouse’s health insurance premiums as a business expense. Additionally, if you have a sole proprietorship or partnership, you can deduct 100% of your spouse’s wages as a business expense, reducing your taxable income.
Example #3: Hiring your parents
Suppose you own a business and your parents are retired and looking for something to do. You hire them to work for you part-time, paying them $10,000 each per year. As a result, you can deduct $20,000 in wages from your business income, reducing your taxable income by that amount. Additionally, your parents will not have to pay any Social Security or Medicare taxes on their earnings because they are over the age of 65.
Conclusion
Hiring your kids and family members in your business can be a smart strategic move, providing multiple tax benefits. These benefits include saving on payroll taxes, enabling income shifting to lower tax brackets, and taking advantage of the family employment exemption.
Payroll Taxes Savings
By employing your children under the age of 18, you can save on Social Security and Medicare taxes. The payments made to your child do not count as subject wages, providing you an opportunity to save a considerable amount of money.
Income Shifting
Income shifting allows you to distribute the income within your family by paying your children or other family members, possibly dropping them into a lower tax bracket. This can result in paying less tax, not only for your children but also for your business as a whole.
Family Employment Exemption
The family employment exemption is applicable to sole proprietorships and partnerships where the partners are parents of the employed children. By benefiting from this exemption, your child’s income remains exempt from FUTA (Federal Unemployment Tax Act) taxes. This way, you can increase the financial stability of your family while reducing additional tax burdens.
When employing family members, always ensure that you are making sound business decisions that are in compliance with federal and state regulations. Track all payments, maintain proper documentation, and consult a tax professional to help you maximize the tax benefits of hiring your kids and family members in your business. Remember, these strategies can be beneficial if executed correctly, ultimately leading to a more profitable and tax efficient family enterprise.
Frequently Asked Questions
How much can I pay my child tax-free in 2023?
The tax-free payment limits for children in a family-owned business are subject to the standard deduction amount. In 2023, the standard deduction is $12,550 for a single filer. This means that you can pay your child up to $12,550 per year without them having to pay federal income tax on their earnings.
Which jobs can children perform in a family business?
Children can perform a variety of jobs in a family business, as long as the tasks are age-appropriate, safe, and in compliance with child labor laws. Some examples include office work, landscaping, cleaning, marketing material distribution, and website management. Ensure that the work is legitimate and contributes to the success of your business.
At what minimum age can a child be put on a family business payroll?
The Fair Labor Standards Act (FLSA) allows children aged 14 and older to work in non-hazardous conditions, subject to specific hour restrictions. However, FLSA does not apply to children working for a parent-owned business. Generally, there is no minimum age for children to work for their parents’ sole proprietorship, partnership (if both partners are parents), or a family-owned corporation.
What tax strategies should be considered when hiring your children?
When hiring your children, consider the following tax strategies:
- Deducting their salary as a business expense, reducing your taxable income.
- Shifting income from a higher tax bracket (yours) to a lower tax bracket (your child’s).
- Taking advantage of the Child Tax Credit if your child qualifies.
- Funding a Roth IRA or another retirement account in a child’s name.
Ensure that your child’s wages are reasonable and similar to what you would pay a non-family employee for the same tasks.
How do you properly pay a family member in a small business?
To properly pay a family member in a small business, follow these steps:
- Ensure the family member’s employment is in compliance with applicable laws and regulations.
- Have a written employment agreement detailing their responsibilities and compensation.
- Pay your family member a reasonable salary or wage that is comparable to market rates.
- Set up a payroll system and withhold the necessary taxes, such as Social Security, Medicare, and federal and state income taxes.
- Provide them with a W-2 or 1099 form, as appropriate, at the end of the year.