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Hiring Your Kids | Tax Sherpa Routes

May 25, 202420 min read

Business owners have a great opportunity to unlock some awesome tax perks by bringing their own kids into the workforce. It's not just about saving money – it's a chance for the little ones to dive into the world of finance early on and get a head start on understanding how money works. By getting their kids involved in the business, business owners can trim down their tax bills while teaching their children crucial money management skills that will set them up for financial independence down the road.

When you think about hiring your kids to work for you, there are loads of benefits to enjoy. You can trim your tax responsibilities through income shifting and maybe even snag some tax breaks by paying your kids fair wages for the actual work they do. Plus, having your kids pitch in can play a part in your estate planning strategies, especially if you run a family business and want to pass things down to the next generation with as few tax issues as possible.

One thing to keep in mind is the "kiddie tax," which basically means that unearned income for kids gets taxed at their parents' rates to stop any sneaky tax dodging. But, if you have your children doing real work for you, the money they earn can be taxed at their own rates, potentially easing your tax load overall. This can be a big plus for small businesses set up as sole proprietorships or C corps trying to make the most of their tax situation while following child labor laws and tax rules to a T.

When it comes to planning for retirement, having your kids work for you can also help with stashing money away in retirement accounts like Roth IRAs or traditional IRAs. By paying your kids for the work they do, parents can make contributions to retirement accounts, kickstarting an early habit of financial planning and paving the way for building wealth in the future. This isn't just a savvy tax move but a great way to teach your kids smart money habits early on.

Dealing with stuff like income tax withholding, payroll taxes, and federal income tax implications when you bring your kids into the workforce calls for some careful thinking and sticking to tax laws. Keeping track of hours worked, wages paid, and making sure you follow child labor laws are key things that business owners have to handle when rolling out this tax strategy. Getting advice from a tax expert can help navigate the ins and outs of tax planning and make sure you milk all the tax advantages that come with having your kids work in the business.

All in all, hiring your kids as part of your business game plan doesn't just give you tax perks and financial advantages – it's also a smart move for passing on financial know-how, nurturing a sense of accountability, and gearing the next generation up for a solid financial future in the realms of income, tax planning, and long-term prosperity.

Setting Up the Right Business Structure

Getting the entity structure right for hiring your kids is critical. If you refer to the IRS' guide on family help you'll see that there are only two entity structures that give full exemptions: a sole proprietorship and a partnership in which all the partners are parents of the child in question.

Enter the Family Management Partnership LLC.

The Family Management Partnership LLC is a strategic choice for business owners considering hiring children as part of their tax planning. By default, a multi-member LLC is treated as a partnership for tax purposes, so no additional elections are needed if the setup is done correctly. The LLC will file a Form 1065 Partnership tax return each year. The members of the Family Management Partnership LLC will be the parents of the kid(s). These days, LLCs are actually easier to form and get banking set up than a general partnership. LLCs also have less regulatory maintenance requirements than corporations. And then we get the biggest benefit of all: full exemptions on Social Security tax and Medicare tax (also called the payroll tax), and Federal Unemployment tax. Most states follow suit and exempt state unemployment tax as well. These exemptions can lead to substantial tax savings for the business while complying with the relevant tax laws.

When compared to using Schedule C (sole proprietorship) for hiring children, opting for an LLC offers a more secure tax strategy. Businesses operating under Schedule C face a higher audit risk, which could potentially lead to complications during tax assessments. On the other hand, structuring the employment of children through an LLC can provide a more stable and compliant approach, reducing the likelihood of facing scrutiny from tax authorities.

C corps, S corps, and other business structures do not get the same benefits of exempting payroll taxes and unemployment taxes. Also, issuing 1099s to your kids does not save on these taxes either.

By carefully considering the tax implications and benefits of choosing an LLC for hiring children, business owners can effectively optimize their tax planning strategies. The decision to utilize an LLC not only ensures tax savings but also enhances the overall tax efficiency of the business, making it a favorable option for those looking to leverage this tax-saving opportunity effectively.

process flow for hiring kids

Bringing Children on the Payroll

When it comes to the mechanics of actually hiring the kids, there are 4 basic questions we hear all the time:

  • How old should my kids be?

  • What should they do?

  • How do I pay them?

  • Where do I get the money to pay them?

We will tackle each of these in order.

How Old Should My Kids Be?

When you're thinking about the best ages to bring kids on board as a smart tax move, it's key to grasp the perks and boundaries that apply to hiring individuals in specific age brackets.

The short answer is between the ages of 8 and 18.

Under 18, they are exempt from Social Security and Medicare taxes (aka payroll tax). They are also exempt from federal unemployment tax (FUTA) and usually state unemployment tax (SUTA) as well. This exemption can translate to solid tax savings for businesses aiming to tap into the skills of young individuals in this age group. By bringing in kids within this range, not only can business owners offer valuable work experience, but they can also slash payroll costs thanks to the exemption.

Over 18, the child retains the unemployment tax exemption until age 21, but loses the payroll tax exemption. Unemployment taxes are measured in the hundreds of dollars a year, so it's not anywhere near as significant a deduction as the Social Security and Medicare taxes.

On the flip side, for kids under 8, there are legal restrictions to take into account. Child labor laws kick in to safeguard the rights and well-being of the youngest ones, limiting their involvement in the workforce. These laws ensure that children prioritize their education and personal growth during their crucial early years, shielding them from work that could hinder their overall development and welfare. 

But I Heard: You'll often hear people talk about how they put their kids pictures on their business cards and websites so they can pay the child as a model. That sort of works, but how much can you reasonably justify paying a child model for 1 hour of work? It's not a lot. 

By recognizing these distinctions across age groups, business owners can make savvy choices about hiring children as a tax strategy. It's vital to navigate the ins and outs of these rules and exceptions to maximize tax benefits while staying on the right side of the law and ethics. Striking a balance between tax perks and compliance with labor laws is crucial for making the most of hiring children as part of a tax-saving strategy within legal boundaries.

What Work Should My Kids Do?

When considering hiring children as part of a tax strategy, it is essential to define suitable job roles for them within the business.

For younger children, typically aged between 8-12 years old, tasks that are age-appropriate and within legal boundaries include janitorial responsibilities such as light cleaning, organizing workspaces, and assisting with simple office administrative duties like scanning mail or shredding documents. These activities not only help instill a sense of responsibility in children at a young age but also provide them with valuable exposure to the working environment.

Example: I set up my 9 year old to scan my mail. I put her at the kitchen table, set her up with a laptop and scanner, and showed her how to open the mail, put it through the scanner, and save the file as a PDF. She went through a whole stack of mail and then she got to do the fun part of shredding all the paper.

As children grow older, between the ages of 13-18, they can take on more complex tasks that align with their cognitive development and interests. Assigning roles such as social media management, conducting research for business projects, and engaging in content creation for marketing purposes can be excellent opportunities for older children to learn valuable skills in areas such as digital marketing, market research, and creative writing.

Keep in mind, these age ranges are approximate and merely suggestions. Like any training program, the work should be within the capabilities of the child but also a stretch to improve development. That stretch might be in the form of the actual task itself or it might be in the form of having regular work hours and committing to tasks.

By offering diverse job roles to children within the business, not only does it assist the business owner in tax planning by potentially reducing the family's overall tax liability through the utilization of their children's lower tax brackets, but it also serves as a valuable learning experience for the children involved. Additionally, it can contribute to fostering a sense of entrepreneurship and work ethic from a young age.

Pro Tip: Whichever job you end up hiring your child for, do 2 things: 

  1. Use an AI system like ChatGPT or Bard to create a job description. Ask the AI system for suggestions on additional tasks this position could be responsible for. You'll probably get great suggestions you never thought about.

  2. Determine a reasonable wage or hourly rate for the work performed. Wage rates vary widely. Use a site like salary.com to look up current rates for that type of job in your area. You might be surprised what different jobs actually pay in the marketplace.

Furthermore, involving children in the operations of the business can align with family business values while offering them practical insights into the mechanics of running a small business. It also underscores the importance of business advisory and planning for the future.

In summary, defining age-appropriate job roles for children within the scope of a tax strategy benefits both the business and the children involved. It establishes a platform for them to contribute meaningfully to the business operations, acquire essential skills, and gain a better understanding of the value of work and financial responsibilities.

How Do I Pay My Children?

When it comes to paying your children as part of a tax strategy, it is essential to follow proper payroll procedures to ensure compliance and maximize tax benefits. Utilizing third-party payroll solutions like QuickBooks Payroll or Paychex can streamline the process and help avoid costly errors in tax filings. While there is a cost associated with using these services, attempting a DIY approach often leads to more expenses in the long run due to inaccuracies and compliance issues.

By entrusting reputable third-party payroll providers, business owners can efficiently manage payroll for their children, ensuring all tax withholdings, deductions, and reporting requirements are handled correctly. This not only saves time but also minimizes the risk of facing penalties or audits from improper filings. Third-party payroll solutions offer the expertise and tools necessary to navigate the complex landscape of payroll taxes, including those specific to hiring children.

Moreover, outsourcing payroll to established providers allows business owners to focus on core business operations and strategic growth instead of getting bogged down in administrative tasks. It provides peace of mind knowing that payroll compliance is taken care of professionally, leaving the business free to thrive and succeed with confidence.

Investing in third-party payroll solutions for paying children within the context of a tax strategy is a wise decision that can yield significant long-term benefits. The initial cost is outweighed by the savings and peace of mind it brings, ensuring smooth operations and compliance with all tax regulations. By leveraging the expertise of trusted providers like QuickBooks Payroll or Paychex, business owners can effectively manage payroll for their children and optimize their tax strategy for overall financial success.

Where Do I Get the Money to Pay Them?

This question is probably the biggest objection we get from clients. "Where do I get the money to pay them?" The real answer lies in the flow of money between your operating company and the Family Management LLC. Here's how it works:

The operating company, typically an S Corporation, channels money into the Family Management LLC. This money becomes a deductible expense for the operating company, reducing its taxable income. For the Family Management LLC, this money is considered revenue. Subsequently, the wages paid to your children become an expense for the Family Management LLC. As a result, the net deduction ultimately benefits the operating company.

This setup not only provides a business expense tax deduction for the operating company but also has a cascading effect. By lowering the available profit from the S Corporation, it reduces the amount needed for W-2 payments to the owner. This integration of different layers amplifies the savings, demonstrating the multiplicative effect of this strategy.

Another aspect of this question is parents' reluctance to pay their children, preferring to use the money themselves. It's important to recognize that you are already incurring expenses for your children (hopefully). This strategy doesn't introduce new costs; it simply redirects the cash flow. By paying your children for their work, you can capture tax deductions while still covering expenses for clothing, sports, hobbies, camps, and after-school activities. The difference is that these costs are now paid out of your children's earnings, allowing you to benefit from the tax savings.

By understanding and implementing this strategy, you can optimize your tax situation while continuing to support your children financially.

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Managing Your Kids Payroll

For those of you thinking about the perks of hiring your kids as a smart tax move, nailing down the payroll game is key to staying on the IRS's good side and milking those tax benefits for all they're worth. Keeping tight records like timesheets and payment receipts is key to show that the cash you're shelling out to your little workers is totally legit.

Time sheets don't have to be complicated. Personally, I just keep a Google Sheet with the date and hours worked. You can get as basic or as complicated as you like though.

Again, when it comes to processing outsource to payroll to pros like Paychex, QuickBooks Online Payroll, ADP, or even your local bank's services. While going the DIY route might sound tempting, it's best to tread carefully because dealing with payroll, especially when it involves your kids for tax purposes, can get pretty tricky.

When it's payday for your mini employees, aim to do it every two weeks and make sure those timesheets are spot on. Just log in to your payroll service of choice, punch in the hours your child worked, and let the system crunch the numbers for you. Since kiddos usually dodge most deductions, the net pay should match what flows out of your company account, except maybe for state withholdings depending on deduction rules.

Once you've punched in the payroll details correctly, sending it off to your provider kicks off the processing, lightening your load and keeping you in the clear with the tax folks. Your payroll service should also handle those pesky quarterly and yearly filings on your behalf, making the tax side of hiring your kids a breeze. By handing off these tasks to the payroll pros, business owners can dive into growth strategies and money plans, capitalizing on the tax perks that come with getting your kids on the payroll.

Tax Benefits and Financial Implications of Hiring Children as a Tax Strategy

When it comes to utilizing the strategy of hiring children for tax benefits, understanding the financial implications is crucial. One key aspect to consider is the Standard Deduction and Tax Exemptions. In 2024, the standard deduction stands at $14,600, providing an opportunity for tax savings. Importantly, any wages paid to children under this standard deduction limit are not subject to income taxes, making it a favorable option for small business owners looking to optimize their tax strategy.

Moreover, IRA Contributions can play a significant role in this tax planning strategy. Children who are employed and earning income are eligible for IRA contributions, allowing them to start saving for their retirement early on. In 2024, the contribution limit for IRA accounts is set at $7,000, offering a tax-advantaged saving avenue for young earners. By leveraging IRA contributions for children, business owners can not only instill sound financial habits but also benefit from potential tax savings, especially when considering higher tax brackets.

Fun Fact: Most people think IRA stands for individual retirement account. It actually stands for Individual Retirement Arrangement. This may sound like just a weird bit of trivia, but it's actually critical when it comes to the power of IRAs to invest in businesses and alternative assets. This is an advanced topic that we discuss in our material on Self-Directed IRAs. You can also read up on Publication 590-A from the IRS.

Incorporating children into the workforce can also lead to important tax considerations for business owners. By providing children with employment and paying them reasonable wages for the work they perform, business owners can manage their tax liability effectively. This approach enables the business to allocate income in a tax-efficient manner and potentially reduce the overall tax burden through income shifting. Additionally, by structuring wages within the guidelines of earned income, business owners can optimize their tax planning strategies while abiding by tax laws and regulations.

Example: Joe runs Joe's Consulting Services and is in the 32% tax bracket. He has 2 children, Bob and Sue ages 14 and 17 who run his social media. Each child earns $21,000 and contributes $7,000 to their IRAs. Joe gets an effective tax deduction on $42,000. At the 32% bracket, this creates a marginal tax savings of  $13,440. This tax savings effectively pays for the $14,000 put into the IRAs. Let's go over that again. Bob and Sue got $14,000 put into their retirement plans for FREE. What does each of their $7,000 turn into after 50 years growing at 8%? About $328,311. That's just for the one year of contributions. That's the power of compounding and starting early.

You could also contribute funds to a Roth IRA instead of a traditional IRA. You lose the tax deduction in the current year but the withdrawal in retirement years becomes tax free under a Roth. There are pros and cons to each and which was is better really depends on what your expectations for future inflation and future tax rates and laws are. Is the savings today worth taking at the expense of potential savings for your kids in retirement 40 or 50 years in the future?

In summary, hiring children as part of a tax strategy not only offers financial benefits such as utilizing the standard deduction and facilitating IRA contributions but also fosters a sense of financial responsibility early on. By incorporating children into the business in a legitimate and structured manner, business owners can navigate tax complexities while laying a foundation for their children's financial well-being. This approach aligns with tax-efficient practices and empowers business owners to leverage the available tax advantages while complying with tax laws and maximizing tax savings within the confines of the law.

Want to see how these numbers will play out in your personal situation? Book a Tax Survey call now.

Additional Benefits of the Strategy

Financial Education

Engaging children in the workforce not only offers them a source of income but also serves as a valuable platform for imparting financial education. By involving children in earning money at a young age, parents can effectively teach them important lessons in money management and financial responsibility. This hands-on experience can instill in children a solid foundation of financial literacy that can benefit them well into adulthood. A 12 year old who learns how to save, invest, and spend responsibly will be lightyears ahead of his or her peers.

Frugality and Responsibility

Furthermore, when children have the opportunity to earn their own money through legitimate employment, they tend to develop a heightened sense of frugality and responsibility towards their finances. This firsthand understanding of the value of money earned through hard work often results in children being more conscious and thoughtful about their spending habits. Such early lessons in financial discipline can significantly shape their attitudes towards money and consumption in the long run.

Long-term Financial Planning

In addition to the immediate benefits of earning income as part of a family business, hiring children can also pave the way for long-term financial planning and wealth accumulation. By starting to invest a portion of their earnings at an early age, children can potentially build substantial wealth over their working lifetime, leading to the creation of robust investment portfolios worth millions of dollars. This foresight in financial planning not only secures the children's financial futures but also sets them on a path towards financial success and stability in the years to come.

Practical Examples and Case Studies

Example 1: Bob is a consultant and has 2 teenage daughters. As part of his overall Tax Trek (step 3 in our 4-Step Process to Tax Peace) we implemented this strategy. We had already applied several other strategies to his situation, but these deductions were the icing on the cake to get him down to the 0% tax bracket. 

Example 2: I've already told you about my own daughter doing office admin work. The math all works out as we've already detailed, but one episode in particular stands out in my memory. My daughter wanted to buy some roller skates. Her aunt showed her how to search for skates on amazon.com and she found a pair of pink skates that she really wanted. They cost $39.99 and she had $36 in cash. She was excited that she almost had enough. Then I had to break the news to her, $39.99 is not the actual price - there's this thing called sales tax. When we added the skates to the cart, the price went up to $42.68. She was disappointed that she was farther away from her goal than she thought, but:

  • A, she now had a goal,

  • B, she learned a bit more about how money works in the real world, and

  • C, she begins to understand the lesson that money is tied to value creation (in her case, labor).

These are critical lessons for any young (or old) person to learn. 

Conclusion

In summary, hiring children as a tax strategy offers a range of advantages, including tax savings, fostering financial literacy in the younger generation, and facilitating long-term financial planning for both the children and the business. By involving children in the workforce at a young age, not only can the business benefit from potential tax deductions and credits, but it also provides a valuable opportunity to instill essential money management skills early on.

For business owners considering implementing this strategy, it is strongly recommended to seek personalized advice from a tax professional. Consulting with one of our tax experts can help tailor the approach to individual circumstances, ensuring compliance with applicable laws and maximizing the benefits of hiring children within the framework of tax planning. With the guidance of a professional, business owners can navigate the complexities of tax regulations concerning child employment and optimize the tax implications of this strategy for both immediate and long-term financial goals.

Book your Tax Survey call with one of our experts now to implement this strategy in your Tax Route now.
 

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Neal McSpadden

Neal went from owing the IRS over $1,300,000 to Zero and in so doing discovered the world of tax planning. Since 2011 he's helped tens of thousands of clients save hundreds of millions of dollars on overpaid income taxes.

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Frequently Asked Questions

Q:

What's the difference between tax advisory and just filing my taxes?

Filing your taxes each year is a necessary task, but it is always backwards looking. Tax advisory works with you throughout the year to make sure that you are on the right track when it comes to your taxes and have strategies in place to save money now.

Q:

I've heard about tax write-offs for small businesses. What exactly can I write off, and how does it benefit my business?

Tax write-offs, also known as tax deductions, are expenses that a business incurs that can be subtracted from its revenue to reduce the amount of taxable income. Common write-offs include office supplies, mileage, rent for a business location, and advertising expenses, among many others. By writing off legitimate business expenses, you can significantly reduce your taxable income, which can lead to a lower tax bill. It's essential, however, to maintain proper records and ensure that the expenses are truly business-related.

Q:

What's the difference between a tax deduction and a tax credit?

A tax deduction reduces the amount of your income that is subject to taxation, which in turn can lower your tax liability. Common deductions include expenses like mortgage interest, student loan interest, and business expenses. A tax credit, on the other hand, is a direct reduction of your tax bill. This means if you owe $1,000 in taxes and have a $200 tax credit, your tax due would be reduced to $800. Some popular credits include the Child Tax Credit, the Earned Income Tax Credit, and credits for energy-efficient home improvements.

Q:

I'm thinking of hiring an independent contractor instead of an employee. Are there different tax implications for each?

Yes, there are significant tax differences between hiring an employee and an independent contractor. When you hire an employee, you're responsible for withholding federal and possibly state income taxes, Social Security, and Medicare taxes from their paychecks. You also typically pay unemployment taxes on wages paid to employees. Independent contractors, on the other hand, are responsible for their own taxes. As a business owner, you'd provide them with a Form 1099-NEC (if you pay them $600 or more during the year) instead of a W-2, and they would be responsible for their own self-employment taxes. It's important to correctly classify your workers, as misclassifying can lead to penalties.

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