Operating a family business oftentimes means exactly that: the entire family is involved, even minor children who may be too young to work outside the family business. There are numerous perks to these arrangements, for the child, parent and business, in addition to several enticing tax benefits for all three. It’s important to pay a reasonable wage for reasonable work and to process payments properly in both the books and on tax returns to avoid audit risks.
Key Takeaways:
- According to IRS guidelines, payment rendered for a child’s services are subject to income tax withholding regardless of their age
- When employed in a family business that’s owned by a parent as a sole proprietorship or a partnership in which each partner is a parent of the minor child, the child’s payments are not subject to social security and Medicare taxes
- Businesses classified as corporations, partnerships (in which one partner is not the parent of the child) or an estate require payments for services of a child to be subject to income tax withholding, social security taxes, Medicare taxes and Federal Unemployment Act (FUTA) taxes regardless of age
- Employed children are expected to do reasonable work for a reasonable wage, and will need to be a reasonable age to complete that work
Employing your minor child at your business is an excellent way to build a family legacy, instill a strong work ethic and provide additional tax benefits. This arrangement also allows parents to begin funding their children’s retirement accounts. Once a child has earned income, they may begin contributing retirement savings to an IRA. Under current law, up to $6,500 a year can be entered into an IRA, traditional or Roth.
Reasonable Age, Reasonable Wage, Reasonable Work
Naturally, it’s inadvisable to pay your child wages when they are not working, or not doing enough work, to earn that wage. Paying your child is a legitimate business expense, but your child must be of a reasonable age and perform reasonable work that you would ordinarily pay someone else to do. While it certainly would be adorable, your three-year-old can’t reasonably be expected to answer phone calls and take reservations, but perhaps your 12-year-old could. Reasonable work might include:
- Cleaning
- Database work
- Filing
- Inventory work
- Maintenance
- Typing
Enjoy Additional Tax Savings
The taxes you would withhold from your child’s wages depend on their age as well as the entity structure of your business. If the business is a sole proprietorship owned by a parent or a partnership in which each partner is the parent of the child, then payments for the child’s services aren’t subject to social security and Medicare taxes, as long as they are under the age of 18. Regardless of the child’s age, income tax must be withheld.
The wages of minor children who work at a family business that is a corporation, a partnership in which only one partner is the parent of the child or an estate are subject to income tax withholding, social security taxes, Medicare taxes and FUTA taxes regardless of their age.
Tax Benefits for Child and Parent Alike
In addition to the cost-saving tax benefits of employing a minor child, you can still claim your working child on your tax return as a dependent, encouraging even more tax savings. Children who earn less than the standard deduction, which the IRS raised to $13,850 to adjust for inflation, do not owe federal income taxes.
Getting your children involved in the family business can be a great idea for many reasons. Before making any major decisions, reach out to your team of advisors to determine your best path forward.
Anders Family Wealth and Estate Planning advisors can work with your family business to set you up for success and reach individual and business goals. Learn more about working with our advisors and the associated fees by contacting Anders below.
