SCFO #011: The Hire Your Kids Tax Strategy For Solopreneurs
Read time: 3 minutes
Many solopreneurs are always on the lookout for effective tax-saving strategies.
One such strategy involves hiring your kids to work in your business, which not only helps you save on taxes but can also provide valuable life lessons for your kids.
Recently, I shared a tweet highlighting this strategy, which you can check out below:
Today, we’ll look at the ins and outs of this strategy, its benefits, and how to navigate rules for hiring your kids.
Please note that this article only scratches what you need to know to execute this strategy.
As always, please discuss this with your CPA.
Before We Dive In: Disclosures
Let’s get some disclosures out of the way because everyone loves those…
The expense to hire your kids needs to be legit.
Unfortunately, you can’t pay your kid to watch Cocomelon all day. I know…the shame.
If you hire your kids, make sure you keep records of:
Time worked
Work performed, and
Reasonableness of their pay
Avoid paying your kids an excessive amount. Instead, pay the going rate you’d pay someone else of their skill level to perform their job.
Also, the work needs to be tied to the business and must be ordinary and necessary.
In my view, this is where the ‘kid modeling’ strategy for your kids can fall short.
To illustrate, if I started paying my 1-year son, Byron, to model for my business, I’d have a tough time defending that expense as ordinary and necessary.
After all, I’ve never paid any model for my business.
And even if I wanted to pay Byron, as good-looking as he is, how much could I reasonably pay him, and how much would I save?
I’d think about those questions before you dive head-first into this strategy.
Please also review Federal and State Child Labor Laws.
Under Federal Labor Laws, there is an exemption for parents to employ their children, assuming (1) your business isn’t hazardous and (2) you and/or your spouse own the business outright.
State laws vary, so please check your state’s labor laws.
As a final note, the youngest age successfully defended in tax court for this deduction was 7 years old (pretty wild).
Why Hire Your Kids?
My kids are currently 4 (Maddie) and 1 (Byron), so we’ve got a while before I put them to work, but when I do, my primary goal is to teach them:
Work ethic
How to manage money
And how to work autonomously
Beyond that, when you hire your kids, you save on taxes.
Let’s run through a quick example:
For 2023, the standard deduction is $13,850 for an individual.
If you pay your kid a reasonable wage of $13,850, your child can offset their earned income of $13,850 with this standard deduction.
Now, at the same time, let’s say your marginal tax rate is 30% (federal and state).
You’d get to write off that $13,850 as a business deduction, saving yourself ~$4,000 in taxes.
And here I thought my kids would only ever cost me money!
Caution: please don’t just pick $13,850 because it helps you maximize the deduction! Remember, the wage can’t be excessive.
State tax rules vary, so please note your child’s income could be subject to state taxes.
What About the Costs?
We talked about the potential savings, but we didn’t talk about costs.
First, you’ll want to consider the incremental costs of adding your kids to payroll as well as the time and effort involved in the strategy.
For Sole Proprietors, Single-Member LLC’s or Partnerships owned exclusively by Husband/Spouse:
FICA doesn’t apply if your kid is under 18
FUTA doesn’t apply if your kid is under 21
SUTA rules vary, with some states (like Illinois) conforming to the FUTA rules
So great news - no payroll taxes other than potentially SUTA (See Section 3 “Family Employees” from IRS Publication 15):
However, payroll taxes do apply if you are an S or C Corporation (or in a partnership where both parents are not the sole owners) 😞.
With payroll taxes at a ~15% clip, you’d be looking at roughly $2,000 of costs on $13,850 of wages, reducing the overall benefit to $2,000 per child.
To get around this, some solopreneurs:
(1) form a family management company (sole prop / SMLLC),
(2) pay a management fee to the family management company,
(3) and pay their kids from the family management business
I won’t dive into that today, but here is an article that does.
Please note that some CPAs view this strategy as aggressive, and you’ll also want to ask yourself if it’s worth the trouble (talk with your CPA/Attorney).
Super-Charge Your Kids Retirement!
My favorite aspect of this strategy is the ability to help your kids get ahead for retirement.
Once Byron and Maddie have earned income, we can contribute up to $6,500 per year into a Roth IRA (2023 maximum).
In the scenario described above, this is tax-free income that goes into a vehicle that is tax-free for the rest of their life!
Another perk with a Roth IRA is that the cost basis is accessible penalty-free before 59.5, so your kid could access that money later for college, their first home, etc.
A nice bonus is that retirement accounts don’t affect FAFSA reporting when your kid applies for college (unless you take a distribution).
But given the choice, that money is likely best spent in that Roth IRA.
At an 8% return, $6,500 alone would be $65,000 in 30 years!!
TL;DR
Hiring your kids can be a beneficial tax-saving strategy for solopreneurs
Play by the rules: be aware of federal and state child labor laws
Keep it legit: document work and pay a reasonable wage (not excessive)
Boost your kids’ future with Roth IRA contributions to supplement this strategy
Consult your CPA: discuss this further with a professional for personalized advice
P.S. if you’re a solopreneur and want to minimize taxes while maximizing financial clarity, book a free 15-minute call today.
Let me help you get unstuck in your personal and business finances, so you can focus on doing what you love.
Disclosure: please consult with your CPA, Attorney, or Advisor to execute this strategy. I am a CPA, but I’m not your CPA.
