Would you like to hire your kids to work for your business?
You can, as long as you follow some simple guidelines.
Business deductions are allowed under the tax law when they are ordinary and necessary expenses paid or incurred as a result of carrying on a trade or business.This includes wages paid to compensate employees for services they provide. Although the Internal Revenue Code does not define a minimum age for employees (common practice advises children be at least 6 years old), “courts generally look to three factors when determining whether or not wages are deductible:
- The wage paid is a reasonable amount,
- The wage is based on services actually rendered, and
- The wage is paid or incurred.”
To ensure that the wages are reasonable, think about how much you would pay an unrelated party to complete the work. For example, you wouldn’t pay someone $1,000 a week to spend one hour a day filing and shredding papers. Establish a realistic hourly wage and create an employment contract with your child (and make sure you keep it for documentation purposes).
Next, confirm that your child actually performs the work. One way to do this is to have your child complete a log or timesheet to record what work they accomplished and how long it took them to complete it. Keep in mind that the work they do must be related (ordinary and necessary) to your business.
We strongly recommend using a payroll service to issue the checks, keep payroll records, and issue a W-2 to the child. HBL provides payroll services and can help you with this. Paying your child this way demonstrates that you are paying your child for services actually performed, as if he or she was your employee.
It is crucially important to document the three items above if you are hiring your child. In a recent court case, a taxpayer was denied the majority of her wage deductions (on her Schedule C) paid to her children because of the lack of documentation.
The taxpayer hired her three children, all of whom were under nine years old, during their summer break from school to perform services such as shredding waste, mailing papers, answering telephones, photocopying documents, and greeting clients. She did this because at times childcare was unavailable and she wanted her children to learn the value of money and develop a healthy work habit. They worked about two hours a day for two or three days a week.
In this case, taxpayer did not issue W-2s or keep records regarding the employment (or payment) of her children. She paid them partly with cash and partly with contributions to their Section 529 Qualified Tuition Program accounts, neither of which was able to be directly linked as compensation for services rendered in the ordinary course of her trade or business. There was no documentary evidence (bank statements, canceled checks, or time records) to show how much was paid to each child, how many hours each worked, or what the hourly rate of pay was. As such, the court was not satisfied with taxpayer’s argument to support the claimed deductions on her Schedule C. However, the court did concede that each child did perform some form of services, so they allowed a wage deduction of $250 per child.
But wait, what about payroll taxes?
According to the IRS, “payments for the services of a child under age 18 who works for his or her parent in a trade or business are not subject to social security and Medicare taxes if the trade of business is a sole proprietorship or a partnership in which each partner is a parent of the child.” Meaning if the parent has a Schedule C or if husband and wife are the only two members of a partnership, the above exception applies and the parent does not need to pay payroll taxes on the child’s earnings. If the business is an S-Corp, a C-Corp, or a partnership with any non-parental member, payroll taxes must be paid in full on wages paid to the child.
Questions? Call us! Alternatively, visit the below sources to read more on this topic.
- The Tax Book News – Wages Paid to Children, ref. Fisher, T.C. Summary Opinion 2016-10