Hiring minor children in a business gives you the ability to shift income from what is most probably the parents’ higher income tax rates to the children’s presumably lower rates. Children are able to have more income with the Tax Cuts and Jobs Act’s approximately doubling of the standard deduction (at 0% rate).

And notably, the so-called “Kiddie Tax” is of minimal concern here, as the Kiddie Tax is a tax levied on “unearned income”, such as interest, dividends, capital gains and distributions from inherited IRAs, 401(k)s, and other retirement accounts. In contrast, income generated from employment (including the parent’s) is considered as earned income. Therefore, the Kiddie Tax does not apply to such amounts, and the full amount of the Standard Deduction (and availability of lower tax brackets) is allowed.

Sample Scenario:

Assuming that you own a small toy store and you are currently in the 35% tax bracket. You have three children (ages 15,16,17) and you are employing all of them to work for the year with each getting $12,500. The deductions for this would cut your taxable income by $37,500. That is $12,500 salary of each multiplied by 3 (children employees). You would then have a tax savings of $13,125 ($37,500 X 35% = $13,125). This amount is a tax savings alone (which is even greater than the salary of one of your children).

As an additional financial benefit, if your children don’t have any other income (other than the one that they earn from working in your business), then the entire $12,500 salary that is being paid to each child is 100% Federal-income-tax-free! So this is another savings for your business.

Tax savings can even be more significant when your business is at or near the new qualified business income (QBI) deduction phaseouts. As an example, the salaries of minor children in the business can help lessen the business owner’s taxable income to they are given a larger QBI deduction.

Additionally, the wages paid to minor children are counted as wages paid for the wages or wages-and-depreciable-property tests for the QBI deduction. This simply means that the wages of these children can slow down the phaseout of the QBI deduction for owners of SSTBs (Specified Service Trades or Businesses) with income within the phaseout range. This can also help in preserving up to the full QBI deduction for non-SSTB business owners who have income that are within or above their applicable phaseout range.

Increasingly, the business owner’s reduction of income via the payment of salaries to minor children, plus the likely increase in the owner’s QBI deduction can give the business the “right” set of facts and circumstances that are almost 50 cents of every dollar paid to a child in Federal taxes.

Apart from the regular income tax savings that you can get when paying salaries to minor children, the Federal tax law also provides potential savings on employment taxes. Sole proprietorships, single-member LLCs, and partnerships (but not corporations, including S corporations) where both parents are the only partners/owners of the business are specifically not required to pay Social Security or Medicare (FICA) taxes when the employed children are under 18 years of age. This particularly means that the children will not be accruing Social Security benefits based on those earnings either, nor do they start accumulating any quarters of coverage to be eligible for Social Security and Medicare benefits in the future.

Moreover, sole proprietorships, single-member LLCs, and partnerships where both parents are the only partners of the business are not accountable for Federal unemployment (FUTA) taxes on children under 21. Those businesses, conversely, may still be obligated to pay state unemployment taxes.

Furthermore, it’s imperative to note that even if a child-employee’s wages are not subject to FICA and/or FUTA, those wages are still subject to Federal withholdings (unless the child is otherwise exempt). Therefore, the children should still receive a W-2 from the business and they may to file a Federal tax return to be refunded for any excess amounts withheld (which would comprise of all of the amounts withheld if their employment income is entirely offset by the child’s Standard Deduction).

Corporations (including S corporations) are not qualified for the special employment tax breaks on FICA and FUTA (even if a child’s parents are the only shareholders of the corporation). So parents (business owners) are given the following options:

Hire the Children Anyway: You may still opt to hire your children via the corporation and simply recognize the restrictions. The combined Social Security and Medicare taxes (15.3%) that would be payable on a child’s salary, plus the federal unemployment tax (6% on the first $7,000 of wages) would still “only” equal about 19% on a $12,500 salary. And apparently, at least some of the Medicare (or Social Security) taxes would have been paid by the parents if the income was allocated to them anyway. So, even with some FICA and FUTA tax duty, there would still be a tax savings to hiring the child in the business, particularly for higher-income business owner parents.

Modify Your Business’ Entity Structure: Another opportunity for a parent in such circumstance is to “scrap” the S corporation and turn the company into a sole proprietorship, single-member LLC, or partnership with the other parent. It’s very unlikely that such a change would be valuable exclusively for the purpose of avoiding employment taxes on a child’s – or even multiple children’s – salary. But given the numerous changes brought about the Tax Cuts and Jobs Act (which includes the potential benefits of non-corporate entity structures for specific business owners with respect to the qualified business income tax deduction), a modification in the entity structure may make sense anyway. The extra employment tax savings of hiring minor children in your business would just be an icing on the cake!

Form Another Business and Hire Minor Children on the New Company: This is a more aggressive strategy to save on employment taxes for parents who want to hire their children to work for their wholly-owned (potentially with the other parent) corporation. You have the option to establish a separate sole proprietorship (or single member LLC or partnership wherein both parents are the only partners) family management company. The said new company (which is employment-tax-savings-eligible family management business) would then

The separate employment-tax-savings-eligible family management company would then contract with the S corporation to provide services, and the family management company would then hire the children to provide those services (i.e. social media marketing, customer support, answering the phones).

For those who wish to use this work-around to avoid employment taxes on hiring minor children, properly keeping records is a must (contract and/or related documentation between the “regular” S corporation business and the newly formed family management company. This would convince the IRS to respect the entity.

With the family management company acting as the employer of the children, it means that it would have to run payroll, issue the W-2s, and file a tax return (likely a Schedule C). This additional work may counteract all or part of the advantages of establishment for some business owners.

When hiring children in your business, you must comply with the same legal requirements as when hiring a non-child employee. You must fill out IRS Form W-4 and complete U.S. Citizenship and Immigration Services (USCIS) Form I-9, Employment Eligibility Verification. The children’s Social Security numbers must also be recorded (have them apply for one if they don’t have it yet). As an employer, you should also have an Employer Identification Number (EIN) and you must also complete and file IRS Form W-2 showing how much you paid your children employees.

• Require minors to have a work permit or working papers (many states do)

• Limit the number of hours or times of day that workers 16 and over may work (many states do)

• Apply if there is no FLSA employment relationship (if the child is not an employee)

• Require breaks, meal periods, or fringe benefits (some states do)

• Regulate discrimination, harassment, verbal or physical abuse, or morality (other federal and state laws do)

There are certain restrictions on employing children based on federal labor laws with each state having specific laws relating to child labor. Please check here  your state’s child labor laws (as they may differ from federal laws). The rule is whichever is stricter or the most protective for the children in a specific situation would be applied.

• For minors age 16 and 17, they may perform any job not declared a hazardous job or occupation and are not subject to restrictions on hours.

• For minors age 14 and 15, they may work outside school hours in different non-manufacturing, non-mining, non-hazardous jobs. This work has limitations on days and hours: No more than three hours on a school day, 18 hours in a school week, eight hours on a non-school day, or 40 hours in a non-school week.

• Minors under age 16 may not start work before 7 a.m. or work after 7 pm, except from June 1 through Labor Day, when evening hours are extended until 9 pm.

• Minors age 14 and 15 may work only in a restricted number of occupations: retail, food service, and gasoline service establishments specifically listed in the regulations.

Employees who are under age 20 should have a minimum wage of not less than $4.25 per hour on their first 90 days (consecutive). However, this should not be a reason for you to replace employees who are over age 20 (or maybe cut their wages, hours, or benefits) just to hire a youth and pay them the minimum amount.

When hiring children as employees (including your own), you have to clearly define the status of these workers. Hiring them part-time or classifying them as “summer workers” can steer clear of misunderstandings about benefits and pay. All information related to the status of minor workers must be included in your employee handbook or policies and procedures manual.