Hiring Your Children in the Family Business: Payroll Exemptions, Limits, and Proof

The idea of paying your children through the business is popular and often oversold. Done properly, it can shift income to a family member with a lower tax rate, create earned income for a child, and teach real work skills. Done carelessly, it produces a disallowed deduction. The distinguishing features are real work, reasonable pay, and paperwork.

The requirements are the same as for any employee

The wages are deductible only if the child performs legitimate services and the pay is reasonable for those services. A 10-year-old cannot reasonably be paid an adult marketing manager's salary for stuffing envelopes. Pay should match what you would pay an unrelated person of that age and skill for that job.

Jobs that tend to be credible

Age-appropriate tasks in a small business include:

Filing, scanning, and organizing documents.
Cleaning the office or shop.
Basic data entry.
Social media assistance or photography, if the child has genuine skills.
Website updates.
Packaging and shipping.
Modeling for the business's marketing, if the child is actually featured in legitimate advertising, at a rate comparable to what a model would be paid. This example is often cited and should be documented carefully.
Running errands, stocking, or customer-facing tasks for older teens.

Child labor laws apply. Federal and state laws restrict hours and hazardous work for minors, though the federal rules have exemptions for children employed by their parents in certain non-hazardous jobs. State rules differ. Confirm before you schedule.

Payroll tax rules by entity type

Sole proprietorship or single-member LLC owned by a parent (disregarded): wages paid to a child under 18 are generally exempt from Social Security and Medicare (FICA) taxes. Wages paid to a child under 21 are generally exempt from federal unemployment tax (FUTA). Federal income tax withholding may still apply, though a child with low income may owe none based on the standard deduction and W-4 entries.

Partnership owned entirely by the child's parents (including a multi-member LLC taxed as a partnership with only the parents as members): the same exemptions can apply.

Corporation or S-corp, or partnership with a non-parent partner: the exemptions do not apply. Wages are subject to FICA and FUTA like any employee's.

State rules on unemployment insurance and withholding may differ from federal rules, so confirm with your payroll provider and state agencies.

The child's tax picture

The child reports wages on their own tax return if they exceed filing thresholds. A child with earned income can use the standard deduction against earned income, which historically has been large enough that modest wages are generally not subject to income tax. The exact amount is inflation-adjusted annually and depends on whether the child can be claimed as a dependent, so confirm the current figure with your adviser. Also, wages can affect other aspects: financial aid calculations, dependent status, and the "kiddie tax" (which applies to unearned income, not wages).

Earned income also lets a child contribute to an IRA (traditional or Roth). Some families use the child's wages to fund a Roth IRA for the child, which can be a strong long-term benefit, but the contribution must come from the child's ownership, and the contribution cannot exceed earned income. The details of gifting money to the child to fund the contribution should be reviewed with a professional.

Documentation to keep

A written job description and any employment agreement.
Time sheets with dates, hours, and tasks.
Payment records: payroll records showing wages paid to the child's own bank account (not the parent's).
Form W-4, I-9, and payroll setup. See payroll for new employers.
Evidence of work product, such as photos, files, and outputs.
Wage rate justification: job postings or wage data for similar roles.
W-2 at year end.

Pay the child for real

Pay should go to an account in the child's name, and the child should have access to it. If the money returns to the parents for personal use, the arrangement looks like a sham. Do not pay in cash without records.

Corporations and other options

If your business is a corporation, hiring children is still possible, but payroll taxes apply. The income tax deduction may still be valuable, so evaluate the net effect. Some families restructure to a parent-owned partnership or disregarded entity to take advantage of the payroll tax exemptions, but restructuring solely for that purpose should be evaluated for business reasons and costs. See changing entity type.

Benefits and retirement

A child employee may be eligible for the business's retirement plan depending on the plan's eligibility rules. In a solo 401(k), employees other than the owner and spouse generally make the plan a regular 401(k) requiring coverage testing, so hiring a child can change plan status. See solo 401(k) guide and SIMPLE IRA guide. Talk to a plan provider before hiring if you have a solo plan.

Common mistakes

Paying above the market rate.
No work performed, or work that a child could not realistically do.
No time records.
Paying into the parent's account.
Assuming all exemptions apply regardless of entity type.
Forgetting to run payroll or issue a W-2.
Ignoring child labor laws.
Not considering the impact on the child's dependent status or financial aid.
Deducting the wages as a "gift." Gifts to children are not deductible.

Realistic expectations

The tax benefit is often modest compared to the effort of documentation. A well-run arrangement can still be a good fit for families where children genuinely contribute. Evaluate whether the administrative burden is worth the tax savings and the developmental value.

For help evaluating whether this fits your structure and how to document it, AE Tax Advisors can assist, and a discovery call is a good first step.