Running a business comes with many challenges, but it also opens the door to unique tax strategies. One often-overlooked opportunity is to “put your kids on the payroll.” Yes, hiring your children to work for your business can provide several tax benefits. Let’s break down how this strategy works and the key things you need to know to make it both effective and compliant with tax laws.

What Does It Mean to Put Your Kids on the Payroll?

Putting your kids on the payroll means employing them to perform legitimate work for your business and paying them a reasonable wage. By doing so, you can claim those payments as a business expense, reducing your overall taxable income. This strategy is particularly beneficial if your children are in a lower tax bracket because the wages they receive will be taxed at their rate instead of yours.

For example, if you’re in the 24% tax bracket and your child is in the 10% bracket, you shift some of your income to be taxed at a much lower rate, lowering your total family tax bill. But to take advantage of this strategy, you need to follow specific rules outlined in the Internal Revenue Code (IRC).

Benefits of Employing Your Children:

1. Deductible Wages as a Business Expense
When you hire your child and pay them a reasonable salary, the wages are considered a deductible business expense under the Internal Revenue Code. This means that any wages paid to your child reduce your business’s taxable income, lowering your overall tax liability. For example, if your business earns $100,000 in profits and you pay your child $10,000 in wages, your taxable business income is reduced to $90,000. This lowers your overall tax bill and keeps more money in your pocket.

2. No Social Security and Medicare Taxes 
One of the most significant advantages of this strategy is that wages paid to a child under 18 are not subject to Social Security and Medicare taxes if the business owners are parents of the child.  Avoiding these taxes means you save on the employer’s portion of payroll taxes, which amounts to 7.65% of wages. So, if you pay your child $10,000, you save $765 just on payroll taxes alone.

3. Exemption from Federal Unemployment Taxes (FUTA)
In addition to the Social Security and Medicare exemptions, wages paid to a child under 21 are also exempt from Federal Unemployment Taxes (FUTA).  FUTA is generally 6% on the first $7,000 of wages. If your child’s wages qualify, this means you save up to $420 per child each year.

4. Shifting Income to Lower Tax Brackets
By paying your child a wage, you are essentially shifting a portion of your business income to someone who is likely in a much lower tax bracket. This strategy is beneficial because your child’s earned income is taxed at their rate, which could be as low as 10% or 0% if their total earnings are under the standard deduction amount ($15,000 for 2025). This could result in a significant family-wide tax saving. Additionally, because your child’s wages are earned income, they are not subject to the “kiddie tax” rules, which apply to unearned income.

5. Utilizing the Standard Deduction

The IRS allows everyone, including children, to claim a standard deduction. For 2025, the standard deduction is $15,000. This means your child can earn up to $15,000 and pay no federal income tax at all. If you pay your child, for example, $15,000 in wages, they will pay zero federal income tax, while you get to deduct the entire $15,000 as a business expense.

6. Funding Roth IRA Contributions
Your child’s earned income can be used to contribute to a Roth IRA. Because Roth IRA contributions can only be made with earned income, having your child on the payroll opens up this opportunity. Roth IRA contributions grow tax-free and can be withdrawn tax-free in retirement. This gives your child a head start on retirement savings, and over time, those contributions can grow substantially due to compounding.

7. Saving for College with Tax-Free Earnings
The money your child earns can be saved for future expenses, such as college tuition or a first car. If you opt to invest their wages in a custodial account, the growth on those earnings can be taxed at their lower rate. Alternatively, if your child’s earnings are contributed to a 529 college savings plan, the growth in that plan is entirely tax-free when used for qualified education expenses.

8. Teaching Financial Responsibility
Aside from the financial benefits, hiring your child can be a valuable life lesson. It teaches them the value of earning money, budgeting, and saving for the future. Your child can learn the basics of personal finance and develop a stronger work ethic by contributing to the family business. This experience could also serve as an opportunity to teach them about the importance of taxes, budgeting, and saving for future goals.

9. Business Growth and Family Involvement
Including your children in your business not only provides tax savings but also fosters a sense of ownership and responsibility. They get to learn the ins and outs of the business, making it more likely for them to continue the family legacy in the future. The hands-on experience your child gains could benefit the business directly, whether they’re helping with inventory management, handling social media, or assisting with customer service.

Key Considerations to Ensure Compliance

While putting your kids on the payroll can be a smart tax strategy, it’s essential to stay compliant with IRS rules. Here’s what you need to keep in mind:

1. The Work Must Be Legitimate and Appropriate for the Child’s Age

The work your child performs must be real work that is necessary for the business. This could include filing paperwork, organizing stock, helping with social media, or even cleaning the office. Make sure the job fits your child’s abilities and age. For example, it’s unreasonable to have a 7-year-old doing bookkeeping, but they can definitely help with simple organizing tasks.

2. Pay a Reasonable Wage
The wage you pay your child must be “reasonable” for the type of work performed. This means you can’t pay them $50 an hour for tasks that would typically be worth $10 an hour. The IRS may challenge the deduction if the wages are too high, so it’s essential to research standard pay rates for similar jobs.

3. Proper Documentation is a Must
You need to treat your child like any other employee. That means having a job description, maintaining timesheets, and issuing a W-2 form at the end of the year. Recordkeeping is crucial to proving that the work was real and the payments were legitimate. Documentation is your best defense against an IRS audit.

4. Taxes and Filing Considerations
Wages paid to your child are subject to income tax withholding, but the child may not owe much (or any) federal income tax if their total earnings are below the standard deduction amount ($15,000 for 2025). The child should still file a tax return to report the income, especially if there were any tax withholdings. This aligns with the “services of a child” rule, which states that compensation for services performed by a child is taxed at the child’s rate.

Potential Pitfalls and IRS Scrutiny

Although the benefits are clear, it’s crucial to avoid some common pitfalls. Paying your child an excessive wage, employing them in work they can’t reasonably perform, or not maintaining proper documentation could raise red flags with the IRS. If the IRS suspects that the payments are not for legitimate work or that the wages are too high, they could disallow the deduction, resulting in back taxes and penalties.

An example of this happening is when a business owner hired their children to do office work but paid them twice the going rate for similar positions. The IRS ruled that these payments were not reasonable and disallowed the deductions. The key takeaway? Pay your child fairly and keep detailed records.

How to Set Up Your Child on Payroll

If you’ve decided this strategy makes sense for your business, here’s how to get started:

1. Determine the Eligibility and Role
Make sure the work is appropriate for your child’s age and abilities. Write up a job description outlining their duties.

2. Process Payroll Correctly
Set your child up in your payroll system like any other employee. Make sure to complete all necessary tax forms, such as the W-4 for tax withholding and the I-9 for work eligibility.

3. Issue a W-2 and Keep Records
At the end of the year, issue your child a W-2 to report their wages. Keep all payroll records, timesheets, and job descriptions on file in case the IRS wants to review them.

4. Consider Additional Tax Benefits
Your child’s earnings could be used to fund a Roth IRA, providing them with a head start on retirement savings. Since contributions to a Roth IRA can’t exceed earned income, having your child on the payroll makes this possible.

Closing

Putting your kids on the payroll can be a fantastic way to save on taxes while instilling a strong work ethic and financial literacy in your children. To make this strategy work, always ensure the work is real, the wages are reasonable, and your recordkeeping is impeccable.  Call us today to setup your Business Income Tax Planning meeting, we can be reached at (480) 980-3977!