Is it actually possible to pay your child a paycheck in your business and be able to pay less tax in your business?
The simple answer is: yes.
But it’s also a little bit more complicated than that.
There are still guidelines and rules that you have to follow when you pay your child in your business.
Does paying your child count as a business deduction?
It does. It counts as employee payroll.
Since it’s employee payroll, you must also follow the payroll tax rules with paying your child.
The IRS knows that business owners put their children on payroll to reduce their taxable income. Therefore they will check to make sure you are also following the payroll tax rules as well. (And a payroll tax audit is just as fun as an income tax audit! You still don’t want it.)
What are the rules to follow?
Yes there are specific rules that you must follow when you hire your child(ren) in your business.
1. They must be an employee in your business.
You can’t just pay your child money to move the money out of your profit. Your child must actually be an employee.
They must do work that is ordinary and necessary to be done in your business.
For example, you are running an online coaching business. Hiring your child to do yard work is not an ordinary and necessary cost of your business. The yardwork is not a part of your business.
But if you were to hire your child to clean your office once a week, that is an ordinary and necessary cost of doing business.
2. Compensation must be reasonable.
The amount of pay that you pay your child should be reasonable for the job that your child is doing.
You can’t pay your child $100 an hour to do social media posting for you. You wouldn’t pay a social media manager that rate, so why would you pay your child that rate?
It also must be reasonable for their age as well.
You wouldn’t pay a 3 year old the same rate that you would pay a 12 year old. They aren’t capable of doing the same jobs.
3. You must follow the legal payroll requirements for your business.
When you hire an employee in your business, you must follow the legal payroll requirements.
That means, you must have a copy of a W-4 on file for your child.
You must issue a check (or direct deposit) to your child to deposit the money into your child’s bank account or an investment account. You can’t just pay cash. There must be a trail of the money paid for the work done.
There should also be time sheets of the hours worked and the work that was completed. These are payroll documents that you should keep on file in your business.
You also must issue a W-2 to your child at the end of the year.
How does the tax work for this payroll?
For anyone under the age of 18, social security and medicare taxes (aka FICA) are not due. Therefore, the amount is not due from the employee or the employer side.
Federal taxes depend on what the standard deduction is on tax returns. For 2020 tax returns, the standard deduction is $12,400.
What that means is that someone can up to $12,400 before any tax is due for federal taxes. (FYI - over 18, the FICA taxes are still due and tax returns must still be filed.)
It is also important to not forget about state and local taxes. The standard deduction for federal taxes usually isn’t the same at the state level. The child is being paid payroll, so the state and local taxes (and tax returns) must also be paid and filed.
Many professionals and business owners will say that you can pay your child $12,000 a year before tax ramifications start to set in.
Technically, yes you can. But there are still other things to think about.
Do I still have to file a tax return for the child?
Some people are going to say no and some are going to say yes.
The best answer is to file it anyway, even if it is a zero balance. You are covering your own behind by just filing.
Have you ever been on the receiving end of a letter from the IRS who says they have information that you didn’t file a tax return or filed incorrectly? Those are not fun. And can end up being more costly than even the amount of tax that is owed. Just file the tax return. You are issuing the child a W-2 for the pay, so file the return.
Yes the child is a dependent on your tax return. But they would still need to file their own tax return as well.
Still want to add your child as an employee?
You still can.
But you may want to talk to a tax professional and get everything set up correctly for your business and your child before you start paying your child as an employee.
When you have things set up correctly from the beginning, then you don’t have to worry about something else going wrong later that can cause even more problems.
Making your pet an employee?
(Yes this has been done before!) No you cannot make your pet an employee.
If you have a disability that requires a service animal, those are a different type of expense deduction that are still ordinary and necessary for your business. But they do not constitute making your pet an employee.
Can you hire your child as an employee?
Yes you can. But you also need to follow the rules that the IRS has set forth.
Not following the rules will result in more problems than you are looking to deal with. I can tell you as a government tax auditor, audits are not fun for either the auditor or the auditee.
Find a tax professional who can help you get this process set up correctly the first time around and make sure you follow the rules and this is a nice tax deduction for your business and some extra cash for your child.
Also check out: Do I have a Hobby or a Business?
All information on this site is provided for general education purposes only and may not reflect recent changes in federal or state laws. It is not intended to be relied upon as legal, accounting, or tax advice. We strongly encourage you to always consult with a tax or accounting professional about your specific situation before taking any action. Please read our full disclaimer regarding this topic.
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