Hiring your children can be a great way to unlock tax benefits for your rental property or other business, while your kids can benefit from real work experience, plus a unique opportunity for them to earn tax-free income or to jumpstart their retirement fund. While the advantages are compelling, success depends on understanding and following the rules and requirements to make this work.
Legitimate Employment
The primary tax advantage is that paying your kids can be a legitimate deductible business expense, just as with any employee. But this can be a strategy that may be scrutinized by the IRS, so it’s important to do it legitimately. Your kids need to be capable of doing the type of work you’re hiring them for, and you should keep a log of their time and activities to help back it up. The amount of pay also has to be reasonable and appropriate for their skill level and the type of work they are doing.
Funding their Retirement
Children who earn income from working in a parent’s business gain access to retirement savings opportunities that are otherwise unavailable to minors without earned income. The primary advantage is eligibility to contribute to a Roth IRA. As long as the child has legitimate earned income, they can contribute up to the lesser of their total earnings or the annual contribution limit. Because kids may pay little to no tax on the income, Roth contributions are especially attractive—tax is paid on the income at little or no cost today, and qualified withdrawals in retirement are completely tax-free.
Starting early can dramatically increase long-term savings due to compound growth. Even relatively small contributions made during the teenage years can grow substantially over several decades.
W-2 vs 1099 Income
The simplest way to pay your kids would be to pay them as 1099 contractors. This would avoid the complexities of tax forms and withholding that is required when you have a W-2 employee, but in most cases it’s probably not going to be the best approach. One reason is that the IRS applies worker classification rules, and children working in a parent’s business may more closely match the definition of an employee rather than a contractor, since you’ll likely have a lot of control over the time, place, and manor of the work they perform.
But aside from that, if you hire your children as independent contractors, they would be required to pay self-employment tax on that income. If you instead hire them as W-2 employees, you can take advantage of a special payroll tax exception applies when you hire your own children in certain family-owned businesses. If your business is operated as a sole proprietorship, wages paid to your child under age 18 are generally exempt from Social Security and Medicare taxes (FICA). This means neither the business nor the child owes the combined 15.3% payroll tax on those earnings, creating a meaningful tax savings compared to hiring non-family employees. But this exception only applies if you as the parent are operating the business under your own name, not with an LLC. This is one of the only circumstances when a single-member LLC has a tax impact, but unfortunately the tax law only allows the FICA exception for hiring your children if you are operating the business as just yourself without an LLC. In addition, wages paid to a child under age 21 are typically exempt from federal unemployment tax (FUTA).
Paying them as a W-2 employee can also often mean they won’t need to file their own tax return. If you pay them as a contractor and they earn more than $400, they would be required to file a tax return. But if you pay them as a W-2 employee, their total earnings are less than their standard deduction (it’s around $15,000, and increases each year adjusted for inflation), and you opt to not withhold taxes from their paychecks, then they won’t be required to file a tax return.
W-2 Payroll and Tax Forms
Having W-2 employees does add some additional tax filing and payroll requirements. Start by obtaining an Employer Identification Number (EIN) if you do not already have one. If your rental property or business is in an LLC, you’ll need an EIN associated with that LLC. If your rental or business is just in your own name, you will also need to request your personal EIN if you haven’t previously done so. You can do this on the IRS website at https://sa.www4.irs.gov/applyein/. Also check for any required employer identification numbers that may be needed in your state.
Even when hiring your own children, a form I-9 is still technically required to verify their work eligibility. You’ll also want to complete a W-4 form for them to calculate their income tax withholding, but you may want to just choose the “exempt” option to simplify the payroll process if their overall income is likely to be fairly low.
You will also need to file the appropriate payroll tax forms. Most employers file Form 941 quarterly to report federal income tax withholding and any applicable payroll taxes, though very small employers may qualify to file Form 944 annually instead. Provide your child with a W-2 after year-end, and submit copies to the Social Security Administration along with Form W-3. States with state income tax may also require state payroll filings, which may include state income tax withholding returns and unemployment insurance reports.
For each pay period that your child does work for your business, you’ll need to actually issue payment to them. Ideally, if they have their own bank account, then you can use a check or bank transfer to transfer the pay to their account. But if they don’t have their own bank account, you should still make some sort of transfer of funds to show that they really are being paid, even if it’s writing them a check that you then endorse and deposit into your own bank account.
If that all seems too overwhelming to deal with, you can greatly simplify the process by outsourcing the payroll and employer tax form requires to a third party service that will take care of everything for you. Gusto is a popular option that is reasonably inexpensive. This type of service can take care of the onboarding tax form requirements, regular payroll processing, and year-end reporting for you.
Summary
When structured properly, wages paid to your kids may be deductible as a business expense while shifting income to a lower tax bracket—often with little or no federal income tax owed if their earnings fall within the standard deduction. For owners of rental properties or other self-employment ventures, this strategy can also support legitimate business needs such as administrative work, cleaning, marketing, or property maintenance. However, the IRS expects these arrangements to reflect genuine employment, with reasonable pay and age-appropriate duties, and the necessary tax forms.
