Put Your Kids on Payroll Instead |

Most parents already spend thousands of dollars on their children every year—clothes, sports equipment, phones, and school expenses.

The problem is that most families pay for those things with after-tax dollars. Your business earns income, you pay taxes on it, and then you use what remains to support your kids.

There’s a smarter approach.

One of the most overlooked tax strategies for small business owners is paying kids out of your business instead of giving them an allowance. 

When structured correctly, paying children from your business can reduce your taxable income while moving that money into your child’s lower tax bracket.

Business owners often ask questions like: 

How much can I pay my kid tax-free? 

What are the tax implications of paying a kid from your business? 

Is paying kids from an LLC allowed? 

The good news is that the tax code includes special tax rules for paying family members, known as the Family Employee Tax Exemption, which can eliminate employment tax when children work for a parent’s business.

When done correctly, this strategy can lower taxes, build long-term wealth for your children, and turn everyday expenses into a powerful tax planning tool.

Before diving deeper, watch the explanation here.

Why Can Paying Your Kids From Your Business Reduce Taxes?

The tax code rewards people who act like employers and investors.

One of the most overlooked tax strategies for investors and small business owners is hiring their own children to work in the business.

Instead of earning income personally and paying for your children’s expenses with after-tax dollars, your business can pay them directly for legitimate work.

Two important things happen when you do this.

First, your business gets a tax deduction for wages paid to your child. The IRS treats those wages as an ordinary and necessary business expense.

Second, the income is taxed according to your child’s tax bracket instead of your own.

Most children fall into a much lower tax bracket than their parents. In many cases, their income may fall below the standard deduction, resulting in zero federal income tax.

This process is called income shifting, and it’s a common strategy used by experienced investors and business owners.

How Much Can You Pay Your Kid Tax Free?

A common question parents ask is, “How much can I pay my kid tax-free?”

The answer depends on the standard deduction for dependents.

Children with earned income can usually earn up to the annual standard deduction amount before federal income taxes apply. In recent tax years, this amount has been around $15,000, though it adjusts periodically.

Here’s a simple example:

A business owner earns $30,000 in business income.

They hire their child and pay them $10,000 for legitimate work.

Now the business income looks like this:

Business income before wages:$30,000

Wages paid to child:$10,000

Remaining taxable business income:$20,000

If the parent is in a 30% tax bracket, shifting $10,000 saves roughly:

$3,000 in federal taxes.

Meanwhile, the child reports the $10,000 in earned income but typically owes no federal income tax because the standard deduction offsets it.

That creates immediate tax savings.

Do You Have to Pay Payroll Taxes When Hiring Your Kids?

Many business owners assume that paying their kids means paying payroll taxes.

But the IRS has special tax laws for family employees.

If your business is:

A sole proprietorship

A disregarded LLC

A partnership where both partners are the child’s parents

Then wages paid to children under age 18 are not subject to Social Security or Medicare taxes.

This exemption eliminates both:

Employer payroll taxes

Employee payroll taxes

That can save over 15% in payroll taxes compared to paying a non-family employee.

However, this exemption does not apply if your business is an S-Corporation or C-Corporation.

But there is still a strategy that can make it work if you own an S- or C-Corporation.

Can You Pay Your Kids From an S-Corporation?

Yes, but proper entity structuring is essential to making the strategy work.

Many small business owners operate through a C- or S-Corporation, which means wages paid directly to children are generally subject to payroll taxes.

Anderson Advisors recommends creating a separate management company LLC.

Here’s how it works:

Your S-Corp hires a management LLC to perform services

The management company receives payment for those services

The management company employs your children

Because the management company is a disregarded entity, it can qualify for the Family Employee Payroll Tax Exemption.

The result:

Your primary business still receives a deduction

Your children earn income at their lower tax rate

Payroll taxes may be reduced or avoided

Proper planning is important when implementing this structure. I would recommend working with your CPA or tax professional to ensure your setup is correct.

What Work Can Your Kids Actually Do in Your Business?

One of the biggest mistakes business owners make is assigning unrealistic jobs to their children.

The IRS requires that children perform real work for the business.

Compensation must also be reasonable for the work performed.

Here are examples of legitimate jobs.

Jobs Younger Kids Can Do

Children ages 6–12 can perform simpler tasks such as:

Cleaning short-term rentals

Organizing receipts

Filing documents

Stuffing envelopes

Preparing mailers

Office cleanup

Inventory organization

These tasks support normal business operations.

Jobs for Teenagers

Older children can take on more advanced roles, including:

Social media management

Video editing

Photography for listings

Website updates

Data entry

Event support

Marketing assistance

Property management support

Teenagers can also assist with operational tasks in real estate businesses, such as:

Preparing rental units

Helping with renovations

Managing marketing campaigns

The key is paying a reasonable market wage for the work performed.

What Documentation Should You Keep for IRS Compliance?

Proper documentation is critical when paying children from your business.

If the IRS ever reviews the arrangement, they will want to see that the work was legitimate.

You should maintain:

Job descriptions

Time sheets

Payroll records

Proof of work performed

Reasonable compensation comparisons

Treat your child as you would any other employee.

That means tracking hours worked and paying them through payroll systems.

This documentation protects the strategy and reduces audit risk.

How Can Paying Your Kids Help Build Long-Term Wealth?

Once your children earn income from your business, they become eligible to contribute to a Roth IRA.

This creates one of the most powerful long-term wealth strategies available.

For example:

If your child earns $15,000 working for your business, they may be able to contribute up to $7,000 to a Roth IRA, depending on the annual limits.

That money grows tax-free for life.

If a child contributes $7,000 per year for 8 years before age 18, that could amount to $56,000 invested early.

With decades of compound growth, that investment could grow dramatically by retirement age.

Few strategies allow families to build wealth this early with tax-free growth.

Can Your Kids Use Their Earnings for Everyday Expenses?

Another benefit of paying children from your business is replacing after-tax spending.

Instead of paying for things like:

Clothing

School supplies

Sports equipment

Personal expenses

with your own after-tax income, your children can use their earned income to cover those costs.

That effectively turns everyday expenses into a tax advantage.

It also teaches kids important lessons about earning, saving, and managing money.

What Mistakes Should You Avoid When Paying Kids From Your Business?

Several mistakes can weaken this strategy.

Avoid these common problems.

Creating Fake JobsChildren must perform real tasks tied to the business.

OverpayingCompensation must be reasonable for the work performed.

Poor RecordkeepingWithout documentation, the IRS may challenge the arrangement.

Using the Wrong Entity StructureCertain tax benefits depend on how your business is structured—you should understand the benefits available as a sole proprietor, partnership, or corporation.

Planning ensures the strategy works as intended.

How Can You Set Up This Strategy the Right Way?

Every business structure is different.

Before putting your kids on payroll, it’s important to understand:

How your business is taxed

Whether payroll taxes apply

What work your children can reasonably perform

How much compensation is appropriate

This is exactly the type of planning our team at Anderson Advisors helps clients with every day.

If you want to implement this strategy correctly and maximize your tax savings, schedule a free 45-minute Strategy Session with a Senior Advisor.

During the session, we can help you:

Determine how much you can realistically pay your children

Structure the payroll correctly

Align your tax strategy and explore additional savings opportunities

Avoid IRS audit triggers

Taking the time to think about your tax strategy now can not only help your children earn income and learn responsibility, it can also help you save more at tax time.