If you are a small business owner, you might be thinking of hiring your children. There are a number of advantages to hiring your children. You are likely considering the opportunity to teach them valuable life skills, showing them the ropes of the family business and even the fact that they are likely more reliable and responsible than a stranger you could hire.
In addition to these practical reasons, there are financial reasons to hire your children as well. We will talk through these reasons and how to do it the right way so you can save money for the business and take full advantage of the tax benefits associated with hiring your children.
Documentation is Key
In the tax world, as you can appreciate, documenting your expenses is really important in the event of an IRS audit. the IRS is more likely to scrutinize transactions that involve related parties. This could be with your spouse, brothers and sisters, parents and children and of course yourself. Depending on what the transaction is, other people could be considered related parties.
What the IRS is looking for here is whether this is something the business would do if the person wasn’t someone that you were connected to. For example, if you hire people to flip burgers at your restaurant and you pay between $10-$15/hr it wouldn’t look good for your child to make $25/hr for the same work.
The IRS wants to understand what work Johnny or Susie is doing for the business and whether they are getting paid a reasonable amount for their work. Similarly, are you keeping track of the hours they work and can you point to tangible work they accomplished? If you wouldn’t accept a certain standard from someone else, you can’t reasonably pay your child for it. Maybe Acme Marketing Company would do a campaign for you that would be a 10 out of 10 and they charge $5,000. If you child is going to do 5 Facebook posts for your business and that would only cost you $300 from Acme, they you can’t pay your daughter $5,000 for $300 worth of work.
To remain compliant, you would want to consider the following things:
- Job Description: If you hired someone for a similar role and you have a standard job description, you will want to be sure that your child will be living up to the same standard as others. If you child is your first hire, it’s worth creating the job description anyway, because you can use it for future hires as well. This will help you measure performance against standards set.
- Employment Contract: Set up a contract when you hire your child. Is the employment for a particular time period? What is the pay – hourly, salary? What hours are they expected to work? When will there be performance reviews and what pay raises are likely for this position? Have all this documented and make sure it’s aligned with what others you might hire would receive for the same work.
- Payment For Services: If you are hiring your child as an employee, make sure to put them on payroll. If they are an independent contractor, have a contractor’s agreement with all the necessary provisions. It could make sense to reach out to a contract lawyer to make sure you are compliant with state laws.
- Document the accomplishments and work completed.
Benefits To You and Your Business
If you follow the proper procedures, and depending on your child’s tax profile, your business can deduct the amount paid to your child as salaries and wages or as payments to independent contractors. If they are employees and they are under 18, often times there isn’t a need to withhold Social Security or Medicare from their paycheck.
Assume your business is in the 24% tax bracket and your child is earning under the standard deduction ($13,850 for 2023) then you are essentially transferring taxable income in your hands to tax free income in your child’s hands. That can be a really nice perk. Even if your child is older and they might make $50,000 or more, if they are in the 12% or 22% tax bracket, this is still a benefit for you. As a parent myself, I can tell you it’s much better to have your children earn money and have a sense of responsibility and it’s even nicer when this means that you pay less taxes.
Of course, there are also some potential drawbacks to hiring your children, such as the difficulty of separating your personal and professional lives and the challenge of disciplining your child if they do not perform well. However, the financial benefits of hiring your children can make it a worthwhile option for many small business owners.