Hiring your child: tax perks and potential pitfalls for families in business

Article | December 02, 2025

Authored by Weinlander Fitzhugh

Hiring your child in your business is one of the most overlooked tax-saving strategies available to family-owned enterprises. And it’s not just about lowering taxes, although the tax savings can be substantial. When structured correctly, employing a child can also support long-term wealth transfer goals, impart financial responsibility, and create meaningful educational opportunities.

But there are also compliance landmines. The IRS pays close attention to these arrangements, especially when the work performed or wages paid raise questions about legitimacy.

In this article, we’ll examine the key tax advantages of hiring your child, the financial opportunities it offers, and the structural nuances that must be carefully managed to make the most of this strategy.

Strategic benefits for the business

For business owners, particularly those running sole proprietorships, family partnerships, or other closely held pass-through entities, employing a child can trigger a significant shift in how income is taxed. Instead of being taxed at the parent’s top marginal rate, wages paid to the child can be taxed at a much lower rate, or potentially not taxed at all.

How it works in practice

When a child is legitimately employed in the business and performs actual, age-appropriate work, the wages paid are deductible as an ordinary business expense. This reduces the business’s taxable income, and because many small businesses are pass-through entities, it also lowers the family’s overall tax liability.

If the child earns less than the standard deduction, which is $15,750 in 2025 (and $16,100 in 2026), then no federal income tax is owed by the child. In effect, that income escapes taxation entirely. The business deducts it, and the child pays no tax on it. This is one of the rare situations in the tax code where the same income can be both deductible and non-taxable, but only if every aspect is properly documented and the compensation is reasonable for the work performed.

The tax efficiency improves further when the business is structured as a sole proprietorship or a partnership in which both parents are sole partners. Under IRS rules, wages paid to a child by one of these entities are not subject to Social Security, Medicare (FICA), if the child is under 18, or Federal Unemployment Tax (FUTA), if the child is under 21 (IRC § 3121(b)(3)(A), § 3306(c)(5)). That exemption, however, does not apply to S corporations or C corporations, where full payroll taxes apply regardless of the employee’s age or relationship to the owner.

Entity structure matters here – and many small businesses operate as LLCs, which brings some complexity. A single-member LLC is typically treated as a disregarded entity for tax purposes and taxed as a sole proprietorship, meaning the child employment tax exemptions would still apply. If the LLC has two spouses as members and files as a qualified joint venture, it may also retain the FICA and FUTA exemptions. But if the LLC is treated as a partnership or elects corporate tax treatment, the exemption status changes. This makes it especially important for LLC owners to understand their tax classification before assuming these payroll tax savings apply.

It’s also worth noting that reducing adjusted gross income (AGI) at the household level can yield additional benefits. A lower AGI can affect eligibility for certain deductions and credits and may help avoid phaseouts or surtaxes, such as the Net Investment Income Tax.

Of course, the IRS is fully aware that this strategy is ripe for abuse, which is why the arrangement must be defensible on all fronts. The work must be real, the compensation must reflect market value, and the employment must be properly documented. 

Financial and educational benefits for the child

While the tax advantages to the business are clear, the benefits to the child can be just as impactful (if not more so) over the long term. Earning income at a young age opens doors that are typically closed to minors, especially when that income is structured and reported correctly.

Retirement savings

One of the most significant outcomes is eligibility to contribute to a Roth IRA. Only earned income qualifies a minor to open and fund this type of account. That means even modest wages from part-time or seasonal work in the family business can lay the foundation for a retirement asset with decades of tax-free growth ahead. A $7,000 Roth contribution made at age 15, left untouched until retirement, could grow into a six-figure sum thanks to the power of compounding – and all of it would be tax-free under current law.

Financial literacy

Beyond retirement savings, the experience of working in the family business can provide children with something arguably even more valuable: financial literacy. Getting a paycheck, seeing taxes withheld, understanding what those deductions mean – these are formative lessons. They bridge the gap between textbook knowledge and real-world application. For many families, this kind of practical exposure helps offset the common challenge of raising financially capable children in environments where money often feels abstract or unlimited.

Educational savings

There’s also the flexibility to use earned income for educational savings. A child’s wages can be directed toward a 529 plan or used to fund a Coverdell ESA. In families with college-bound children, this income can even reduce the Expected Family Contribution (EFC) on financial aid forms, since student-earned income is assessed differently than parental income under FAFSA guidelines.

Compliance considerations and pitfalls

For all its benefits, hiring a child is not without risk. The IRS has clear rules around family employment, and the burden of proof falls squarely on the business owner to show that the arrangement is legitimate. The closer the relationship, the higher the scrutiny. That’s why documentation, compensation, and business structure matter as much as the work itself.

Reasonable compensation

The first issue is reasonable compensation. A child can be paid for real work, but not at inflated rates. The wages must reflect what an unrelated employee would earn for similar duties. Paying a 12-year-old $40 an hour to file paperwork or manage a company’s Instagram feed is unlikely to survive an audit, even if the business is profitable. On the other hand, $12 to $15 an hour for simple administrative or marketing tasks may be defensible if the child is actually doing the work and hours are tracked.

Documentation

That brings us to documentation. This is not the place to cut corners. The work should be clearly defined, with a job description outlining responsibilities appropriate to the child’s age and skill set. Time logs or weekly work summaries should be maintained. Payroll should be run through a proper system, and W-2s must be issued. Simply writing a check or transferring money into a child’s account is not enough. Treating your child like any other employee, on paper and in practice, is essential.

Entity type matters

Business entity type adds another layer of complexity and opportunity when employing a child. Sole proprietorships and partnerships in which both parents are the only partners generally offer the most favorable tax treatment. In these cases, wages paid to a child under age 18 are not subject to Social Security, Medicare, or FUTA taxes. 

That payroll tax advantage doesn’t apply if the business is structured as a corporation (whether an S corp or a C corp). In those cases, children are treated like any other employee, and wages are fully subject to FICA and FUTA. But this does not disqualify the strategy or eliminate its core benefits. You can still deduct the child’s wages as a legitimate business expense, shift income into a lower tax bracket, and provide the child with earned income that can be used for savings, retirement, or education. The overall strategy remains viable, just not quite as tax-efficient at the margins.

For some families operating under a corporate structure, there may be ways to work around this limitation. One option is to establish a management company or family LLC taxed as a sole proprietorship or qualified joint venture. This secondary entity can employ the child directly and, if structured properly, restore the payroll tax exemption. That said, these arrangements require careful coordination and should only be implemented with guidance from a tax advisor or legal counsel, since they introduce new compliance obligations and entity-level risks.

Child labor laws

Finally, child labor laws can’t be overlooked. While federal law permits children to work in their parents’ business in many cases, state laws vary. Some states limit the number of hours minors can work, impose restrictions on hazardous tasks, or require work permits even for family employment. These rules apply even when wages are minimal and the work is remote or seasonal. Ignorance of the law is not a defense, and violations can jeopardize both the tax benefits and the business’s standing.

The bottom line is that the IRS is not opposed to children working in a family business, but they are quick to disallow deductions that look like disguised gifts or lack economic substance. The more closely your arrangements resemble traditional employment (with real duties, fair pay, and formal records), the safer and more sustainable the strategy becomes.

Age-appropriate roles and examples: putting the strategy into practice

The type of work a child can reasonably perform, and how that work is compensated, depends heavily on age. The IRS expects roles to be appropriate for the child’s maturity and ability, and that expectation is shared by state labor departments. When done thoughtfully, however, even young children can play a meaningful and defensible role in a family business.

Case study 1: the sole proprietor

Take, for instance, a dentist who operates as a sole proprietor and hires her 15-year-old son to scan documents, organize files, and help digitize patient intake forms. He works six to eight hours per week during the summer and a few weekends during the school year, earning about $6,000 annually. The work is real, the hours are tracked, and his hourly rate matches what the practice would pay for similar entry-level help. Because he’s under 18 and the business is a sole proprietorship owned by a parent, his wages are not subject to payroll taxes. The business deducts the wages, the child pays no income tax (since the earnings fall below the standard deduction), and the family benefits from a simple but effective income shift. Better still, his income qualifies him to contribute to a Roth IRA, which his parents help him fund.

Case study 2: S-corp workaround

In another example, a family running an S-corp wants to employ their teenage daughter, but they know the corporate structure doesn’t offer the same payroll tax advantages. Instead of abandoning the idea, they establish a small management company (a disregarded entity owned by one parent as a sole proprietor) to handle internal marketing and operations support. Their daughter is hired by this entity to manage the business’s social media presence and help with email marketing campaigns. Her compensation is tracked carefully and reported via W-2. Because the management company is a sole proprietorship, her wages are not subject to FICA or FUTA taxes, and the deduction flows through to the overall business structure. The setup requires more planning and oversight, but it’s fully compliant and allows the family to realize the same tax benefits despite the corporate parent entity.

Case study 3: a modest start for young children

Even younger children can participate when the role is clearly tied to a legitimate business function. A graphic designer, for example, uses photos of her two children, ages 7 and 10, in marketing materials and social media posts. The children are paid modest modeling fees, supported by comparable rates from local agencies. Payments are documented, taxes are withheld, and the business retains proof of how the images were used. 

The bigger picture

These examples reflect a broader principle: the younger the child, the more narrowly defined and carefully documented the role must be. Tasks should make sense given the child’s age and the business’s actual needs. Filing paperwork or organizing inventory might be suitable for a pre-teen. Teenagers, particularly those with digital skills, can take on more complex responsibilities like content creation, customer engagement, or even light bookkeeping. As long as the work is real, the pay is reasonable, and the documentation is in order, the IRS has little grounds for objection.

Strategically, these arrangements can serve as more than tax strategies. They can be early lessons in responsibility, personal finance, and entrepreneurship. 

A smart move – if done right

Hiring your child can be a powerful way to reduce taxes and build generational wealth. But like any tax strategy, it must be executed properly, with clear documentation, age-appropriate work, and respect for employment laws.

This strategy works best for families with active businesses and a long-term view of financial planning. If you’re considering it, contact one of our expert advisors to ensure the arrangement is both beneficial and compliant.