Tax Planning for Small Business Owners Hiring your kids or spouse in your business

Why owners hire family

A child or a spouse who does real work in the business can be paid like any other employee. The pay is a business deduction, which lowers your profit. A child usually pays little or no income tax on it, because the child can use the standard deduction against wages. Over a year, that can move several thousand dollars from your tax bracket to theirs.

Children: the rules depend on the business type

If the child works for a parent's sole proprietorship, or a partnership in which each partner is a parent of the child, pay to a child under 18 carries no Social Security or Medicare tax, and pay to a child under 21 carries no federal unemployment tax. Income tax withholding rules apply at any age.

If the business is a corporation, including an S corp, or a partnership with other partners, the child's wages carry Social Security, Medicare and unemployment tax like anyone else's. The wages are still a business deduction, so hiring a child can still help. The payroll-tax savings just don't apply.

Spouses

When one spouse works for the other's sole proprietorship, the wages carry Social Security and Medicare tax but not federal unemployment tax. Paying a spouse a wage can let the spouse put money into a retirement plan of their own, and a Solo 401(k) can cover both of you.

What makes it hold up

The work has to be real, and the pay has to fit the work and the child's age. Filing, cleaning the shop, answering phones, social media posts and data entry are common jobs. Keep a simple time record, pay by check or direct deposit through payroll, and file the W-2 like any employee's. Pay that's far above what you'd pay someone else for the same work is the kind the IRS questions.

A worked example

Here's an example with made-up numbers. A sole proprietor hires her 16-year-old son to clean equipment and handle filing after school, about 8 hours a week at $15 an hour. Over 50 weeks that's $6,000 of wages. Her business deducts the $6,000, and because she's a sole proprietor, no Social Security or Medicare tax applies to it.

If she's in the 22 percent bracket, the deduction lowers her federal income tax by about $1,320, and it also saves the 15.3 percent self-employment tax she'd have paid on that $6,000 of profit, about $848. A working child can use the standard deduction against wages, so her son owes no federal income tax on the $6,000. Her son could also put some of it into a Roth IRA.

Questions about hiring family

Can I hire my 8-year-old? Only for work a child that age can really do, at pay that fits it. Keep careful records. Older children are easier to support.

Do I need payroll for my kids? Yes. Run their pay through payroll and give them a W-2. We get it running with whichever payroll provider you choose.