Should you hire your kids?

Alternate image text: Serious-faced baby working on toy laptop computer 

Should you hire your kids? I get this question a lot. 

Let me start by saying I am not a CPA and I am not currently licensed by the SEC to give financial advice. Always check with your own advisors about your specific situation.  

So think of this like we met at a cocktail party, and we’re getting to know each other. I’ll start. I am Mom to a just-turned-six-year-old named Jake. He recently started first grade and has enjoyed taking on more household tasks in exchange for a small allowance.   

My youngster has a newfound love of Minecraft and Pokémon cards, funded by birthday money and said allowance.  

And you ask, ‘Hey, have you considered hiring Jake? Is that something you can even do?”  

And I would tell you, why yes, he just turned 6. He loves to shred paper, open mail, and tape boxes shut (so, so much tape), so he’s going on the payroll for a few hours a week. 

Jake can learn some work skills in my business and take over some things I might hire a PA to do. The bonus: employing him will also create some tax benefits for me. 

Hiring Your Kids 

The IRS says you can benefit from hiring your kids up to age 21 as long as they can do meaningful work. Meaningful work is relative, but typically by age 6 when they can read, sort things, and lift stuff. (You and your accountant can debate whether your muscle-bound preschool genius qualifies.) You can also hire your grandkids or parents 

This gets interesting when you, the business owning parent, begin to ascend our progressive income tax structure. Here in California, the top state and federal tax rates add up to almost 55%. So for every additional $1 I make in regular income, I keep 45 cents. Oof. 

Kids’ earned income is counted separately from yours. They get their own standard deduction of $12,000, which means they pay $0 in federal income taxes on the first $12,000 they earn. For every dollar Jake makes, he keeps $1. Which he could use to buy his own Pokémon clothes, Pokémon cards, and Pokémon in-app purchases.  

By contrast, if I had income of $100,000 and paid myself that incremental $12,000, I’d have to pay 12-22% to the federal government plus my 2021 state taxes (rates for all 50 states), depending if it’s my year to be single or head of household.  

And with what’s left, I would….buy most of that Pokémon crap. (It teaches him math and strategy! I get a damn hour to myself on the weekends!) 

You can see how this starts to get interesting as you have more taxable household income. And if one of your goals for owning a business is to build intergenerational wealth, the options get more intriguing. See the Advanced Options section below. 

The Ground Rules 

Here’s where to start. 

    • Profitability: You should be profitable. If not, this can get dicey with the IRS. You and your accountant can agree to the audit line.
    • Registrations: You need an EIN (federal business tax ID) and a proper setup as an employer in your state / city. It’s free to file for an EIN directly with the IRS. State registrations typically have a small fee if you DIY through the secretary of state, a little higher if you use a human-supported legal service like CorpNet. If any of this makes you nervous, invest in help. (Disclosure: I get a referral fee from CorpNet should you purchase services via this link. Thanks for supporting my writing!) 
    • Employment: You need to properly hire your child as a W-2 employee. However, the withholding requirements depend on your incorporation status: 
      • Sole proprietor, LLC, husband and wife partnership: you don’t need to withhold state or federal payroll and unemployment taxes. 
      • S-corp or C-corp: run it through your existing payroll with withholding. You pay 7.65%, they pay 7.65%.
    • Workers Comp: You also have the option to waive the workers comp requirement in most states if your dependent is covered by your family health insurance. (Single parents, tread carefully. Your kid must be on YOUR health insurance.) 
    • Tax Filing: Wages under $12,400 don’t require a separate federal tax return (although you may still want to file a 1040EZ if your kiddo qualifies for a refund – does your accountant love me yet?)
    • Meaningful Work and Reasonable Wage: Your child has to do some type of meaningful and necessary work for a reasonable wage. For younger kids, shredding paper, light cleaning, packing merchandise, counting things, drawing a t-shirt design, and organizing marketing swag bags. Nine-year-olds can make social media reels. Older kids can train on Kajabi or Hubspot and try out areas of interest. 
    • Bookkeeping: Kid wages are wages, and wages are qualified business expenses. Make sure you record wages and payroll tax line items in your financial reports.  

So your kiddo is earning money and building their resume. Wouldn’t it be great to save some of that money?  

The Advanced Options 

Money from employment is earned income. That means your kids can have qualified retirement accounts, even when they’re six.  

    • Up to $6,000 of 2021 earned income can be contributed to a traditional IRA or Roth IRA. 
    • Roth IRAs accumulate earnings without any future tax obligations. In other words, you put in after tax money, and you never get taxed on the growth. But Roth IRAs have income restrictions based on adjusted gross income (AGI) thresholds. Which you might not meet, but your kids making under $12,000 sure do.  
    • Qualified retirement savings are disregarded on FAFSA, the federal student aid evaluation. 

Let me play out a scenario for you: 

    • You pay your kiddo $6,000, or $6,459 if you’re an S-corp or C-corp. 
    • You open a Roth IRA in their name and add the $6,000. 
    • You can use the money if needed, or leave it invested, in my six-year-old Jake’s case, for up to 66 years.

Roth IRAs are pretty cool. Here’s why: 

    • Whatever amount that account grows in the future remains tax-free and you can choose pretty much any stock, bond, ETF, mutual fund, or REIT you want.  
    • If you need the original $6,000 in the future, it’s available without tax or penalty for any reason.  
    • You have ways to access the earnings penalty-free for a few things, including education and unreimbursed medical expenses, birth or adoption expenses, or up to $10,000 for a first time home purchase. See the full list 
    • If you do not need to access the money, your kiddo potentially has a nice head start on retirement savings, which they don’t have to touch until age 72. Use the Rule of 72 to see how much that $6,000 could grow. (Link has a video in which they illustrate the math part.)    

Most of us look to a 529 savings plan for kids. These also let you use the earnings for K-12 and college tuition tax-free. And don’t get me wrong – if you have loads of after-tax money sitting around, a 529 plan could be awesome for you.  

But try taking $50,000 out for a first home down payment. Or $11,000 to freeze eggs. Penalty city. 

If you are looking for tax savings right now combined with future wealth-building for your kids, it’s worth doing your own homework on hiring your kids and helping them save with Roth IRAs. 

Common follow-up questions: 

    • Can I make my kid a 1099 contractor? Not until they’re 18. Minors can’t make contracts. 
    • Can I pay my kid more than $12,000? Yes, if it’s justified. Keep a tax reserve based on their incremental state and federal tax rates. Consider opening a separate bank account. If it’s going to be a lot more and you don’t want them to blow it on Pokémon cards, talk to your advisor about setting up a trust.
    • Can I hire my kid past the age of 21? Of course, you just lose the withholding waivers. Make sure you withhold the proper state and federal taxes and comply with workers comp requirements. 
    • Can my kid work for me if they don’t live with me? Yes, if they can get on Zoom and do meaningful work remotely, they can work for you. Make sure you’re registered as an employer in the state where they do the work and comply with local workers comp rules. 
    • Do you really talk like this at cocktail parties? Yes, my nerd flag is flying at all times. If you mention you have a business or are thinking of starting one and leave a socially acceptable opening, it’s on. I respect your right to recall your Paperless Post. 

You don’t have to host a cocktail party to ask me wonky business questions. Grab a free 20-minute Strategy Session (and an optional drink) and let’s talk. 

This article was originally published in our weekly newsletter on September 28, 2021. Want to get the goods first? Subscribe now.

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