Updated: Oct 23, 2021
Hiring children in a family business has been a hot topic in the past few years within the entrepreneur groups that I am part of on social media. If you're active on Facebook or YouTube you've probably seen it too.
It has been exciting to see my fellow female and black entrepreneurs learning about this tax savings strategy but it has also been disheartening. I've seen a lot of people hire their children successfully and then I've seen a lot of people do it wrong due to the misinformation that also goes out on social media.
You CAN hire your minor child as an employee in your business and lower your federal tax bill however it must be done correctly and there are other taxes your child will have to pay. This post will tell you:
The headline that catches most of my peers attention is, "pay your child tax free!" You may be thinking, that's not possible or only the rich can do that. Well, guess what...you can do it too!
The thing is, it isn't 100% tax free. You won't pay employer taxes if you have it set up correctly(which we'll cover in the next section) but your child's earned income from being an employee for your business will be taxable.
Taxpayers with eligible social security numbers are eligible to the standard deduction. The standard deduction for 2021 is $12,550. This means that the first $12,550 of your child's income will not be taxed at the Federal level. There wages will however be taxed at the state and local level depending on where you live. If you're a taxpayer in the 22% tax bracket and you pay your child $12,550 for the year you've already saved roughly $2,761 by shifting the income to your child while yet keeping the buying power within your home.
That's not all! When you hire employees you have to pay employer taxes which consist of Social Security, Medicare, and Federal Unemployment Tax (FUTA). The employer portion of Social Security and Medicare is 7.65% of the wages paid. Taking this into consideration you'll save an additional $960.08 just by hiring your child and paying them $12,550 vs. someone else. That's a total tax savings of $3,721.08 just by hiring your child. However minors are not exempt from payroll taxes so you won't save the $960.08 if you don't have your business structured properly. So let's take a look at what that looks like.
The Correct Entity Type
Now that you know how much you can potentially save by using this tax saving strategy you're probably ready to hire your child but before you do make sure you're set up correctly to take full advantage of the tax savings.
Payments for the services of your child under 18 are not subject to Social Security and Medicare IF and only if the business is a sole proprietorship or a partnership. The partnership only qualifies if each partner is a parent of the child. Once your child turns 19 their wages become subject to Social Security and Medicare but they are not subject to FUTA.
If your business is a corporation and you hire your child you will still pay employer taxes. If your business is a partnership but one of the partners is not the child's parent you will still a pay employer taxes. The correct entity type to hire your child and not pay employer taxes is a sole proprietorship or partnership.
There are certain documents that the IRS requires when hiring employees. Hiring your children is no different if you want to take advantage of this tax savings and have it stand before the IRS so let's look at what those requirements are for 2021.
Employees must fill out a W-4 to let their employer know how much to withhold. Hiring children is no different. Even though you may plan on paying them below the standard deduction having a W-4 on file for all employees is a requirement.
For help filling out the W-4 properly check out "How to Fill Out a W-4 Properly and Avoid Owing the IRS".
The payroll records should be kept 4 years and include:
Employer Identification Number (EIN)
Amounts and dates of Wages
Names, addresses, social security numbers, and occupations of employees and recipients
Employee copies of W-2s
Dates of employment
Copies of income tax withholding certificate forms (W-4)
Dates and amounts of tax deposits made and acknowledgement numbers for deposits made
Records of fringe benefits and expense reimbursement
If this list seems overwhelming reach out to a payroll company or accountant. Don't fall into the trap that I've seen many fall into and "just 1099" your child. 1099s are not issued to employees. They are issued to contractors and open your child up to a completely different tax situation where they will be subject to self-employment tax and the clock starts ticking on that once they make their first $400.
I personally am in favor of hiring children as a tax saving strategy and encourage those that ask to do so with a plan and proper implementation.
Now that you know what records to keep, what business structure to set up, and how much you can potentially save will you execute this strategy? Let me know in the comments below if you'll be hiring your child in your family business!
Timalyn S. Bowens EA is America's Favorite EA and Louisville's Tax Expert that will work hard to find a legal solution that is customized for you! As an Enrolled Agent licensed through the Internal Revenue Service Timalyn is able to fight the IRS for taxpayers in all 50 states.
When you are facing questions regarding your personal or business taxes, working with a professional makes all the difference. At Bowens Tax Solutions, we serve our Louisville-area neighbors by providing the tax services and knowledge needed to succeed. We are here to assist you with your tax issues and preventative care. Visit our website at www.bowenstaxsolutions.com for more information.