Paying Your Kids Through Your Business

It can be a wise, income-shifting strategy to pay your child through your small business. The business can deduct the wages as a business expense and the child reports the income (typically, in a lower tax bracket than yours). That child can then begin to contribute to a Roth IRA, for example, and enjoy decades of tax-free compound growth.

There are also other perks. Under the tax code, if the child is under age 18 and an employee of the parent’s sole proprietorship or a partnership in which the parents are the only partners, neither the business nor the child have to pay Social Security and Medicare taxes on those wages. Similarly, if the business meets the same requirements and the child is under age 21, the business does not have to pay unemployment taxes on those wages. These perks do not exist if the business is a corporation. If the business is a corporation, the child and business must pay the aforementioned taxes.

But, paying a child through a business can be sticky business. How can you do it the right way? In brief, this is because the IRS can try to reclassify the payments as gifts. In order to take full advantage of this benefit as a small business owner, treat the child as you would any employee.

The biggest item is ensuring the child contributes to the business in a meaningful way to pay them through the business. This all depends on the business and its responsibilities, as well as its market, but it can be done.

1. They also must be compensated fairly; establish a reasonable wage for the work performed. Maybe the child is of the age to contribute to administrative tasks; what would be the market wage for this work? Maybe they are young and used to advertise the business; what would be the cost of a similar model? You get the idea.
2. Have formal documentation for your employee. This includes a formal employee agreement, W-2, and Forms 941 & 940. A W-2 is applicable if the gross wages paid to the employee for the calendar year exceed $599.99.
3. It also goes without saying adherence to minimum wage laws is a must. This is rarely an issue as most individuals are guilty of paying too high a reasonable wage vs. too low.

In brief, doing it right is the way to go. It can be a great benefit to your business, as well as for your child’s future. Let me know if you’d like to discuss in greater depth.