Should you employ your kids? There’s recently been a renewed interest in this strategy on social media. People say that the rich “save money” by employing their kids – but is that true? And is it worth it for you to consider putting your kids on the payroll?
Who Can Employ Their Kids?
Technically speaking, anyone who owns a business CAN employ their kids. But depending on the type of business entity you own, the tax benefits can vary. Business owners running sole-proprietor businesses are the ones who will be able to reap the most tax benefits by employing their children. This is because there are unique rules for sole-proprietors that don’t apply to other entity types.
What Are The Advantages of Employing Your Kids?
There are two main tax advantages to employing your kids.
- If you pay your kids up the standard deduction, they will not pay income tax. In 2023, the standard deduction is $13,850. If you weren’t employing your kid and instead keeping the amount paid to them as part of your income, it would be taxed under your income rate. By shifting it to your kid, your child collects the full amount taxed at 0%.
- You are not required to pay social security or medicare – IF you’re a sole-proprietor. This means you would save 15.3% of whatever you pay. This is only true for kids under the age of 18. If your entity isn’t a sole-prop, you would still be required to pay social security or medicare.
Creating a Sole-Proprietor Family Management Company
There is one way to capitalize on the full savings even if your primary business entity is not a sole-prop. You can separately create a sole-proprietor family management company specifically to pay your child. This requires more complicated administrative and management work – this includes hiring a payroll management company to run payroll for your child. But the savings could make it a worth-while option for you and your family.
Here’s how it works: your primary business (most likely an S-Corp) pays into your family management sole-prop, then your child is paid through the sole-prop. In this exchange, you and your child receive the full benefits listed above AND your S-Corp receives a deduction for whatever amount is paid to the family management company. It’s a win-win-win.
What Are The Parameters of Employing Your Kids?
There are some additional complications to employing your kids. It’s not as simple as just saying that Timmy and Marie work for you! You must legitimately employ your kids in order for this strategy to work. That means you need to track the hours they work and pay them at an appropriate rate for the work they’re doing for you. Keeping accurate records and appropriately paying your kids for real work is essential in case of audit.
Benefits for You and Your Kid
For you, there are huge savings benefits. If you have an average tax rate of 25%, the income paid to your child instead of to yourself will save you roughly $3500. In addition to awarding you with significant savings, it also gives your child a jump-start in their own savings. Because they now have an earned income, your child can begin funding their retirement. This is an early start that the majority of their peers won’t have that can drastically impact their future. When it comes to investing, time is your biggest asset, and this is how many use this strategy to ensure their kid is a millionaire by the time they are ready to retire.
Should Your Employ Your Kids?
Bottom line: Is employing your kid worth the administrative headache?
The Encurio perspective is yes! It’s absolutely worth it, as long as you’re paying your child at least $5000 per year. If you paid any less, the administrative cost would outweigh the tax advantages. As long as you have a plan for how to track, manage, and pay your child more than $5000 per year, the tax savings make this a no-brainer.
If you’re interested in employing your kids, but not quite sure how to make it happen, we can help! Set a meeting with us and we’ll help you get started.