Broker Check
Can I really hire my kid tax free?

Can I really hire my kid tax free?

July 29, 2023

Yes, maybe, as long as you do it properly.

One of the things that is very prevailing out there in social media or in seminars is financial advice that is enticing but sometimes misleading or incomplete.  A common one on some sites is people making lots of noise telling people to hire your kids, pay them $12,000 tax free to them and a tax deduction for you.

Sounds good doesn’t it?  But will those people be there at your side when you get audited?  When you tell the auditor that you got your tax advice from social media, how official do you think that will be?

Getting ideas from a variety of sources is a good idea.  But you need to follow that up with talking to your tax and finance professional person who is willing to be there at your side.

Can you hire your kids in your business?  Yes, subject to various labor and tax laws.

Can you pay them $12,000 tax free?  No, if they aren’t doing $12,000 work of legitimate work.

Your kid needs to be like any other employee, they need to do time sheets to document how much they worked, when they worked and you should have a job description for what they do just like any other employee.

They need to be doing work commensurate with their age and abilities.   Your nine-year-old is probably not helping you fill out paperwork or doing filing or answering phone.  Your teenager maybe.

Your five-year-old certainly isn’t doing those things.  But perhaps they are part of your advertising and essentially being a model in your marketing efforts so they could be paid as a model.

How much can you pay them?  When I get asked that, my answer is usually what would you pay your neighbors kid to do the same thing, what would you pay any other employee to do the same thing?

If you wouldn’t pay your neighbor’s kid $12,000 per year to take out the office garbage and clean up the break room, then you’re going to have a hard time supporting that paying your kid is worth that much pay.

That’s where the social media folks trying to sound knowledgeable and gain followers usually fall short because its pesky details like that which they don’t want to get into and it’s not their problem if you get audited and can’t support your deductions.

But where does that $12,000 number come from anyway?  They are talking about the federal standard deduction limit.

But what about state taxes?  Again, not talked about in anyone I’ve heard on social media.  If your state standard deduction is lower than the federal and you pay your kid over that limit be prepared to pay state taxes even if you don’t have to pay federal taxes.

So can you hire your kid and get a tax deduction for your business?  Yes, as long as you do it right and can document it.  There are different rules whether you have a single member LLC or an S corporation so be prepared to research those.

But let’s assume you can hire your kid and pay them and its real work.  How do you do that?

My suggestion is do not pay cash. They may want it and you may think its easier, but again documentation is your friend in an audit.   They should get a real paycheck which means you need to pay someone to process payroll for you.

Because it’s an important life learning experience they should get their own bank account to deposit their check into and my personal belief is that instead of direct deposit their first few checks should be on paper and you take them to the bank and they manually deposit it to learn how that process works.

Then, one of my favorite parts of the whole process, is to contact me and we will set up a Roth IRA account for your kid.   To contribute money into an IRA you need earned income, money you earn from providing a service. 

We can then set up a Roth IRA and subject to the annual limits and their gross wages you can help them get started on retirement savings and use that as another life learning event to get them started on becoming more financial literate.

That’s why I advise them getting a real paycheck, which means a W2 at year end as documentation of the earned income and then take it a step further and have them do a tax return to report the income and learn how that works too even if they get no refund.

As noted above they may not owe federal tax, but depending on the state deduction and how much they earned its possible they may have a state taxable event so it’s a great opportunity to teach them how to do a simple tax return. 

If you really wanted to push the learning envelope, have some taxes withheld from their paycheck and then they have to wait to get it back when they file the tax return to teach the importance of tax planning to minimize owing tax or waiting a year to get a refund of your own money.

Just be very careful especially if you aren’t doing your own return because there are boxes to check on their tax return and if you don’t do it, you the parent may lose out on deductions and credits on your return.

Now that your kid has income, let them start paying for some expenses that you might have paid for them out of your own pocket.  If you’re like our household you might find that’s easier said than done.

When I tried that with my kids they quickly pointed out that as a parent I should pay those anyway so they should get to spend their money on movies and snacks or whatever they wanted.   I give finance and tax advice, so I’ll leave that one alone for you to deal with as parents.

Action items as we wrap this up:

Do you have a business that could actually hire your child?

Can you justify whatever amount you pay your child?

Is your financial team (financial and tax advisor) ready and willing to give you the help you need in this area to get the process going?

The information in this and other articles is intended to be educational in nature only.  Not tax, legal or investment guidance for you specifically.  Each person’s situation is unique and you must seek appropriate professional guidance that can address your unique situation.