Save a Bundle in Taxes by Paying Your Kids
- Xa Hopkins
- 6 days ago
- 6 min read
Paying your kids can be a phenomenal tax-savings strategy for business owners, but it must be done right. You must actually pay them (and follow other applicable business formalities), and the amount paid must be a reasonable salary for services rendered. Payroll tax savings in addition to income tax savings may even be available! There are also additional concerns and benefits to keep in mind when deciding whether to implement this strategy.
Following business formalities
The Internal Revenue Code allows businesses to offset income by deducting “ordinary and necessary” expenses incurred in pursuit of profit. You cannot deduct payroll expenses (or any other expenses!) that exist without evidence. When it comes to paying your child, you must show that you paid your child for work when they complete it, rather than estimating the value of their work at the end of the year. If you cannot demonstrate that you incurred a particular expense, any deduction claimed for that expense will be disallowed, and various penalties could apply.
Following proper business formalities ensures that you will be able to substantiate all income and expense items, including payroll. To pay your child, actually write the checks or electronically transfer the money, so that the money leaves the business account and gets deposited in a bank account belonging to your child. If your child does not already have a bank account, open one for them! You will need to file quarterly payroll tax reports, pay applicable payroll taxes, and issue a W-2 at the end of the year. Depending on their amount earned, your child may also need to file their own tax return.
Whether involving your kids, other employees, or both, there are many pitfalls surrounding payroll filings. Do not attempt this on your own. Use a payroll service. While staying on top of these filings can be difficult, compliance is easy when you use a reputable payroll service.
In short, be sure that the IRS can follow the money. Because paying kids can significantly reduce your tax burden, the IRS closely scrutinizes this type of deduction. This may sound intimidating, but do not shy away from a deduction for which you qualify—just be sure you can justify it!
Reasonable salary for services actually rendered
It is not enough to simply pay your child and submit all proper payroll tax filings. The more challenging obstacle facing business owners paying their kids is determining the appropriate salary. Whether a flat amount or an hourly wage, the child’s compensation must represent a reasonable salary for services actually rendered.
Start with “services actually rendered.” You cannot legitimately claim a wage expense for someone who does no work for your business. Your child must provide services that somehow benefit the business. This will, of course, vary by age. There is not much your three-year-old can do for most businesses, but your nine-year-old can help on the farm or clean a rental property to some extent. I once stayed at a family-owned motel where two kids, both of whom looked about twelve, handled check-in and delivering towels. A young child may deserve a small salary for your photography business if they model some accessories for the local kids’ store. Assess whether your child could reasonably organize files, straighten up your home office, or any other attributable task before claiming they do the work.
After determining the services your child will provide, you can determine their wages. Here again the touchstone is “reasonable.” Think of reasonableness as the going rate in your area for that particular type of work. If the employee concerned was not your child, how much would you be willing to pay? That amount is a reasonable wage. Yes, the IRS will do a wage comparison analysis if your wages paid seems off. Paying your child $100/hour for alphabetizing files or sweeping the floor will not suffice, especially if the minimum wage in your area is $10/hour—but if the minimum wage is $18.50/hour, then perhaps $25/hour could be reasonable, particularly if you can show you pay other employees doing similar work more than the minimum wage.
Payroll tax savings
Business owners love to pay their children because of the tax savings. If you are in the 24% federal tax bracket, you shave $240 off your federal income tax liability for every $1,000 in wages paid. If your child is in the 0% tax bracket, that entire $240 represents income tax savings for the family unit. Even if your child is in the 10% tax bracket, the family unit still saves the difference: All else being equal, your child paying $100 in federal income tax is better for the family unit than you paying $240 in federal income tax. Simply take the difference between your marginal tax rates and multiply that by the amount paid to see the savings. (The same analysis applies to determining income tax savings at the state level.)
Income tax savings alone, though, may not be enough to justify the additional compliance costs, especially once you consider payroll taxes. Federal and state unemployment taxes are both fairly minor, but Social Security and Medicare taxes add up quickly. Social Security is a flat 6.2% tax on wages, and Medicare is another 1.45%. In addition to withholding Social Security and Medicare taxes from employee paychecks, the employer must match those contributions. When employee withholding and employer matching are combined, this results in a total tax of 15.3% (or $153 per $1,000 of wages).
At this point many business owners will decide against paying their kids because the $153 in payroll taxes plus the hassle and expense of payroll compliance is too high a price to pay for a mere $240 savings in federal income tax.
However, depending on the business structure, the payroll tax might not apply! Business owners who pay their children are exempt from federal payroll taxes—Social Security, Medicare, and federal unemployment—on those wages if the business is taxed as a sole proprietorship or a partnership in which the only partners are parents of the child. (Additionally, an exemption from state unemployment tax is often available when an employee is exempt from federal unemployment tax.)
Notice that the focus here is on the tax treatment, not the legal structure. The most common structure for small businesses is a limited liability company (LLC), but that could be taxed in several different ways. If an LLC files taxes as an s-corporation, the family payroll tax exemption does not apply. Meanwhile, an LLC that is a disregarded entity for tax purposes, and files taxes as a sole proprietor on Schedule C, E, or F within the personal tax return of its owner, can take advantage of the federal payroll tax exemption.
Additional tax considerations
There are two important additional tax considerations when it comes to hiring your children: the federal standard deduction and your state standard deduction.
In 2026, the federal standard deduction for a dependent child is their wages earned plus $450, with a minimum of $1,350 and a maximum of $16,100 (which is also the standard deduction for individual taxpayers who are not dependents). A dependent child with less than $450 in non-wage income, such as savings account interest, will pay no federal income tax—and not even be required to file a federal tax return—if their total income is less than $16,100. Given this threshold, many parents aim to pay their child $16,000 a year, but they must demonstrate that they meet the “reasonable salary for services actually rendered” requirement.
A child not required to file a federal tax return may still have a state tax filing requirement. For instance, while Arizona has a standard deduction that mirrors the federal amount, California sets their standard deduction independently. In 2026, the California standard deduction for a dependent is a maximum of $5,706. As a result, a fourteen-year-old dependent living in California who earns $6,000 in 2026 must file a California tax return despite having no federal filing requirement.
In short, pay attention to both federal and state filing requirements since they may be different.
Additional nontax considerations
There are also myriad nontax considerations involved with hiring your children. These nontax considerations will vary considerably depending on your particular circumstances. Here are the most common:
Child labor laws: Follow all applicable federal, state, and local labor laws. (Many child labor laws and regulations do not apply to children employed by their parents, but be sure to check.)
Student financial aid: Wages earned could impact student financial aid.
Personal finance: A child who is earning money is better poised to learn about banking, budgeting, and the value of money.
Roth IRA: An individual must have earned income to make Roth IRA contributions. Earning W-2 wages qualifies. Start a Roth IRA as early as possible to take advantage of the power of compounding growth!
Bonus tip: A child making Roth IRA contributions should file a tax return, even if not required, to avoid IRS scrutiny.
Second bonus tip: A dependent child who is not required to file a tax return should open a Roth IRA, not a traditional IRA. There is no short-term benefit either way, and the long-term benefits for the Roth option are substantially better.
Deciding whether, and how much, to pay your child involves a lot more nuance than you might suspect. Consult a trusted tax professional to decide if this strategy is right for your situation and to implement it properly should you decide to move forward.
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