If you own a small business, hiring a family member is the same as hiring any other person — with a couple of important exceptions. When you employ your children or even your parents, you might be eligible for significant federal tax benefits. Once you’ve familiarized yourself with all the available perks, you’ll be ready to take full advantage of the ones you qualify for when tax time arrives.
Tax-free and tax-deductible pay
If you hire your child to work for your small business, you can pay them up to the annual standard deduction ($13,850 for 2023) without being required to withhold income taxes. According to an article by Stephen Fishman for Nolo, this can help you shift business income from your higher tax bracket into a lower one. It also allows you to keep more money in the family. As an added bonus, you may even be able to deduct your child’s salary from your taxes as a business expense.
FICA tax perks
As an employer, you’re required to withhold Social Security and Medicare taxes (known as FICA) from your employees’ paycheck. However, if you are the sole proprietor of your business and employ your under-18 child, their pay is exempt from this requirement. This exemption also applies if your business is a partnership between you and the child’s other parent. It’s important to note, though, that you’ll be required to withhold these taxes if your business is a corporation or a partnership with someone who isn’t also the child’s parent.
Federal unemployment tax perks
Business owners are also required to withhold federal unemployment taxes (known as FUTA) for their employees. However, if your child is under 21 years old and works for you, their paycheck isn’t subject to this rule. There’s another twist to know about here — if you employ your parent, you don’t have to withhold FUTA from their pay, either.
A retirement savings boost
Employing your child now can provide a financial advantage for you both. According to an article for the Small Business Administration by Barbara Weltman, you can open an IRA for your child as long as they make earned income. Depending on whether you choose a traditional or Roth IRA, your child can make tax-deductible contributions now or make tax-free withdrawals later using their pay from your business — and enjoy tax-free investment growth along the way.
Important rules to know
If you decide to employ your child and claim tax benefits, Fishman summarizes three rules to be aware of. First, your child will need to be a real employee, performing work that is relevant and helpful for your business. Keep careful track of the work they do so you can demonstrate that it’s for business and not a personal or household task. Second, you’ll need to compensate your child reasonably for the work. Third, it’s crucial to follow all of the relevant local, state, and federal laws related to tax paperwork, child labor, and employment. Following these three rules will help you take effective advantage of tax breaks while avoiding potentially costly or damaging missteps.
If it makes sense for your small business and your family life, employing your children can be a savvy way to reduce your taxes. Be sure to consult with a tax professional for advice and assistance along the way so you can successfully adhere to all rules and regulations set forth by the IRS and other authorities.