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Your children are too old for day care, but you aren't thrilled with the idea of leaving them to fend for themselves while you are at work. The solution? Hire them to help out in your business and reap tax benefits as well as peace of mind.
Hiring your children to help with your business during the summer, enables you to:
In addition, having your children learn your business can help with business succession planning--either by preparing them to take over the business, or by alerting you to the fact they have different career interests.
Children Must Be Reasonably Compensated for Actual Work
Hiring your children, even pre-teens, as employees is perfectly legal. The child labor laws (federal and state laws govern the number of hours children can work) usually do not apply if the child is working for his or her parent in a non-hazardous, non-manufacturing business. While you are free and clear for federal child labor law purposes, you should check your state's laws to make sure that state employment laws don't apply.
While hiring your children is legal, paying them for work they haven't performed, or paying them more than you would pay a stranger off the street for the same work, will land you in trouble with the IRS. The IRS demands that the compensation paid to any employee (yourself, your spouse, your children, unrelated third parties) be reasonable for the job performed. Therefore, it's necessary to match the job to the skill, education, and maturity level of the child, and to pay reasonable compensation for the work actually performed.
Tip. If you hire your child to perform substantially the same work as another non-related employee, then you can use that employee's starting wages as a guideline. If you hire your child to do work that is not currently being performed by another employee, you can check with other businesses in the area or benchmark the job description online, using a website such as salary.com
By paying your children a salary for working in your business, rather than paying them an allowance, you are able to claim a business expense deduction for "compensation paid" on your tax return.
No Employment Taxes Are Due When You Pay Your Child
In addition to the income tax deduction, you get another tax benefit when you hire your children: no employment tax payments are required in many cases. Generally, if you hire an employee, you must withhold the employee's portion of the FICA tax (5.65% of wages in 2011) and pay the employer's portion of the FICA tax (7.65% of wages in 2011.) However, no FICA tax is due on payments to your children who are under age 18 (age 21 if they are doing domestic work in your home). In addition, no federal unemployment tax payments (FUTA) are due for payments to your child who is under age 21. Income tax withholding on wages is required, however.
Warning. In order to claim exemption from FICA and FUTA taxes, you must operate your business as a sole proprietorship or as a partnership. However, if you operate as a partnership, both parents must be partners. If you operate your business as a corporation, the regular rules regarding FICA and FUTA apply.
The ability to deduct the amounts you pay your child and the potential savings on employment taxes are two reasons to consider hiring your children to work in your business.