Hiring Your Kids: Tax Savings Without Breaking Labor Laws

What you’ll get in this quick read:

• • How employing your children can save you money on taxes
  • Why most people get this wrong
  • Resources for executing this tax strategy the right way

Boring topic alert…

Well, kind of. I love scrolling through social media and seeing people stating that they take advantage of the “income shifting” strategy to pay their kids in their business.

This is called an “income shifting” strategy because theoretically the parent is in a much higher tax bracket than their child and by paying a kiddo to work in the business you can take a business deduction at a higher tax rate (22%, 24%, etc.) and your kid will pay zero (or almost zero) taxes.

But how does this work?

And to be perfectly honest, in almost 20 years in the tax business, I rarely see this strategy implemented correctly. So, let’s introduce you to what you need to know to properly execute this strategy.

Keep in mind, this is a resource to introduce you to the core concepts that you need to know.

A more in depth resource (an educational video and a step by step playbook) can be found here for you to get deep into this strategy and execute it the right way!

Now, you may have heard many things about paying your kid but there are a few common questions that come up with this topic:

• Does this break any labor laws? 
• How much can I pay the child?
• What kind of work can the kiddo do?

So, let’s take a look at these things:

Does this break any labor laws?

I grew up in a household of 9 and am child number 2 of 7. My siblings would probably say we were raised in a labor sweatshop but I look at my childhood as a fun time where my parents taught us how to find “joy in the journey” and to “stick to the job like glue, stick to the job till it’s through!”

Are you really an entrepreneur if you haven’t dragged your kid along with you to the office, a job site, or made them sit quietly while you finish a meeting or task?

And yes, I’m joking when I say you’re not an entrepreneur… the point is that the children of the self-employed see the hard work that their parents are doing and there is a very high probability that the kids are participating in some way, shape or form in the business of the parent.

Regarding the question of “child labor”, I am not an attorney. I do not pretend to be an attorney and if this is legitimately a concern of yours, I counsel you to consult an attorney regarding this issue.

hat being said, in my professional opinion, it is reasonable to see where your own child or a member of your household could be employed by you. It would be more difficult to argue the employment of a child or someone who was not living with you or related to you. That is an area where I would recommend seeking the opinion of legal counsel when employing minor children who are NOT directly related to you.

Now, with that out of the way...

How much can you pay a child?

The answer is simple:

You can pay them what you can support as a reasonable wage for work performed.

Let me frame it to you this way.

The youngest age that has been tested by the tax courts is the age of 7.

That means that there was a court case where a taxpaying citizen was able to defend that they paid their 7 year old to perform services for their business.

Framed another way, what duties and tasks can a child legitimately perform in your business.

Start with defining what your child can actually do for you in your business and evaluate how many hours that is and how much you would pay someone else to perform those services.

We go deeper into this topic in the resource you can find here along with a playbook for determining what you can have your kiddo do for your business.

But keep in mind that to survive an audit by the IRS you are going to need to show that the kiddo was doing enough work to justify what you are paying the child.

As a general rule, we like to guide our clients in this way:

• Establish a duties and responsibilties list
• Give your child control and responsibility to complete these tasks
• Have your child complete a time card to document their work

The incentive for doing this strategy is that you can pay a child up to the STANDARD deduction (for 2024 that is $14,600) and they will pay no income tax!

So, as if I am in the 24% tax bracket then that $14,600 will translate to tax savings of $3,504.

If I am in the 32% tax bracket then that same $14,600 will translate to tax savings of $4,672.

That may not be massive tax savings but if you carry out this strategy there are massive tax savings to be had in this way:

• If your child has earned income through a W-2 wage that you are paying them, they are now eligible to contribute to a ROTH IRA.
• ROTH IRA’s are funded with after tax dollars and then grow TAX FREE!

Just for fun, let's estimate the future value of max funding a Roth IRA for your kiddo from age 7 to 18 with an annual rate of return of 7%, to arrive at the value at age 60.

First, we need to make some assumptions that the maximum contribution limit remains constant at $6,000 per year. This is not the case as the amount you can contribute increases each year.

Your child will contribute from age 7 to 18, which is 12 years of contributions. The investment will then grow from the age they stop contributing (end of age 18) until they are 60. 

The future value of a Roth IRA max funded from age 7 to 18, with the investments growing until age 60 at a 7% annual rate of return, would be approximately $1,383,793.

This reflects the power of compounding over a long period and making the assumption that your kiddo does not hijack the fund by pulling the money out before retirement age!

And it also assumes that they make no additional contributions and that the 7% rate of return is sustained over that period of time. That is actually a very conservative rate of return by financial advisory standards. 

But that’s a substantial chunk of change and only ONE amazing way that you and your business can impact your child's future and leave a legacy!

It is our opinion that another way you are leaving a legacy for your kids by optimizing this tax strategy is that you teach them how to both earn and manage their finances from a very young age.

Another frequently asked question regarding this strategy is how the wages of the kiddo can be used.
Clearly, funding a retirement account that can grow tax free is absolutely recommended and acceptable.

What is NOT acceptable is that your kid buys groceries for the family, pays rent to you, or covers utility bills for the household. The money needs to be directly tied to the benefit of the child and be something that is both normal and customary for a child.

I hate to break it to you but a 7 year old paying rent to mom and dad is neither normal nor customary (unless you live in a Harry Potter style story book… and we don’t so that is obviously fantasy or a work of fiction.)

What could be reasonable and is directly tied to the child are instances such as:

• Your kiddo is participating in a sport or extracurricular activity where they need uniform, equipment, etc. If the child is earning money, they can fund these needs themselves.
• Your child is invited to participate in a friend's birthday party. Instead of you as the parent buying the birthday present, you allow your child to buy the present out of their own money. I like to ask my kids “Is this a “Dollar Store friend” or is this a “Target or Walmart friend”? By that I mean, “Where do you want to shop for this friend's gift and what kind of money do you want to spend on this present?”

1. Snag the training and playbook for this tax strategy, and
2. If you found this valuable, please share this with a friend… after all, Friend’s Don’t Let Friends Overpay The Government!

Thank you for your time and consideration in reading this.

P.S.- On one final note, this is only one of dozens of incredibly powerful tax strategies.
If you are lacking this strategy one must wonder what other strategies you are currently NOT taking advantage of.

We can serve you and would love to connect with you to create your very own CUSTOM tax savings roadmap!

Book a time and let’s get your tax savings rolling to keep your hard earned profits where they belong… in your bank account, your home, and your community.