Paying children through a family business

In short

A friend of mine once asked if she could pay her ten year old to fold flyers for her bakery. I told her the answer was yes, but only if the work is real. When an owner's child does honest, age fitting work, the wages can be a deductible business expense. The child must actually do the job, and the pay has to be fair for what was done. A simple record of hours, tasks, and each payment keeps the books clean. Paying by check or bank transfer works better than a drawer of loose cash. A tax adviser can explain how the business type and the child's age change the payroll rules.

The whole of it

What it is

I once watched a father hand his daughter a broom and call it a job. She swept for ten minutes, he handed her a twenty, and they both felt proud. Nothing wrong with that at the kitchen table. It gets different when the money comes out of a business and shows up on a tax return.

If you own a business, you may pay a family member for real work, and the pay can count as a business expense. That includes your child. The Internal Revenue Service publishes the rules in Publication 15, known as the Employer's Tax Guide, and in Publication 334 for small business owners. Both are free on irs.gov.

The idea rests on one question. Would the business pay a stranger to do this task? If a stranger would be hired to answer phones, stock shelves, or take photos for the website, then a child can be paid to do it too. The pay must match what the work is worth. A child who files papers for two hours is not worth $500 for the afternoon. Reasonable is the word that keeps everybody safe.

This is a little unusual, so it deserves honesty. It is not a loophole or a trick. It is ordinary employment that happens to involve a relative. The same rules that bind any employer bind the parent.

How it works

If you are holding a small business and a willing teenager, here is how the path runs. The child does real tasks. The business pays wages for those tasks. The business records the pay as a deductible expense, and the child may owe little or no income tax on it.

The business type matters a great deal. A sole proprietorship or a partnership owned only by the child's parents has special treatment for children under age the current figure, which the official source publishes each year. In that case, the wages are generally not subject to Social Security and Medicare tax, and the business may not need to withhold them. A corporation works differently, and the child is treated like any other employee. Publication 15 spells out these differences, and the Social Security Administration explains how wages build a work record.

Federal law also sets limits on child labor. The Department of Labor publishes them through its Wage and Hour Division. Children working in a business wholly owned by their parents have more room than children working elsewhere. Dangerous jobs and some hours remain off limits. A state may add its own rules, so the state labor department is worth a look too.

The child needs a Social Security number and a Form W-4 on file if the business runs payroll. Some small owners use a payroll service, and some do it by hand. Either way, the business must report the wages. A Form W-2 goes to the child at year end when payroll applies. The money belongs in the child's own account, because it is the child's earnings, not the parent's.

A good time log is a small thing. It lists the date, the task, and the hours, and it takes thirty seconds a day. An auditor reading that log sees an honest arrangement.

The numbers, and where to find yours

Plenty of folks like to know the figures before they start, and I do not blame them. Three numbers matter here. Each one changes by year, so none of them should be carved in stone.

The first is the standard deduction, the amount of income a person can earn before owing federal income tax. It is the current figure, which the official source publishes each year for a single filer this year. A child who is claimed as a dependent has a different rule. The IRS limits that child's standard deduction to earned income plus a small added amount, up to the full standard deduction. Publication 501 lays out the exact formula and the current figures.

The second is the age line for the Social Security and Medicare exemption, which is the current figure, which the official source publishes each year for a parent owned sole proprietorship. The third is the minimum wage, which is set by federal law and by each state. The Department of Labor lists the federal figure, and each state labor department lists the state figure. The higher of the two applies.

A few weeks ago a neighbor asked where to look all this up. The place to start is irs.gov, where the publication numbers I named can be searched. A tax preparer can then answer whatever questions are left.

A worked example

Let me tell you about a woman named Maria Alvarez, who runs a small candle shop as a sole proprietor. Her son Daniel is fifteen. Over the summer he works at the shop, labels jars, packs online orders, and sweeps the floor.

Maria checks what a stranger would earn for the same tasks. A part time helper in her town makes $12 an hour. Daniel works 15 hours a week for 10 weeks, so he works 150 hours in all. At $12 an hour, 150 hours comes to $1,800.

Maria pays Daniel by check every two weeks and keeps a log. The $1,800 is a business expense. Say her tax rate on business income is 22 percent. Then the deduction lowers her tax by about $396, because $1,800 times 0.22 is $396. That figure is only an illustration, since her real rate depends on her whole return.

Daniel earned $1,800, which is far below the standard deduction of the current figure, which the official source publishes each year. So he would likely owe no federal income tax on it. Because Maria's shop is a sole proprietorship and Daniel is under the current figure, which the official source publishes each year, no Social Security or Medicare tax comes out either. He deposits the full $1,800 in his own account.

Look at what happened. Maria got a fair deduction. Daniel got a paycheck and a lesson about showing up on time. Nobody bent a rule. That is the whole point.

Where it goes wrong

I have seen good people trip on this, and it is almost never from bad intent. Usually it is from sloppiness.

The biggest trouble comes from pay with no real work behind it. If a nine year old is on payroll for $20,000 and nobody can say what the child did, the deduction will not hold. The IRS can disallow it. Pay that is too high for the task draws the same trouble. Reasonable pay for real work is the shield.

Skipping the paperwork hurts too. No time log, no payroll record, and no bank trail makes a fair arrangement look shaky. Cash handed over with no note is hard to defend.

Some owners also forget that business structure changes everything. A corporation cannot use the parent only exemption, so the payroll taxes apply as they would for anyone. The business must withhold and file as the rules require.

Another slip is treating the child's wages as the parent's spending money. The pay belongs to the child. Taking it back undoes the whole arrangement.

Last, watch the child labor limits. Hazardous work is closed to young workers no matter who signs the check. Hours are limited too, and the Department of Labor and the state labor department set the rules for school weeks.

Questions to answer before you leave this page

Would your business pay a stranger to do the work your child will do, and at what hourly rate? Can you describe each task in a sentence, and does it match your child's age and skill? Is your business a sole proprietorship, a partnership of the parents, or a corporation, and how does that change the payroll tax rules for your child? Have you read the Department of Labor child labor rules and your state's rules for the hours and jobs you have in mind? Will you keep a simple time log with dates, tasks, and hours, and pay by check or transfer into the child's own account? Does your child have a Social Security number, and will the business file a W-2 if payroll applies? Have you asked a tax professional to look over your plan before the first paycheck goes out?