Eight Tax Smart Tips for Hiring Your Children

(Time is running out to pre-order The Doctors Guide to Navigating a Financial Crisis, which comes out next Tuesday.)

I have had several people ask me what must be done to hire their children and set them up with a Roth IRA from the money they earn. This question arose from page 32 of my book, The Doctors Guide to Real Estate Investing for Busy Professionals, where I encourage parents to hire their kids and invest money they earn in their child’s Roth IRA. Today I will cover some of the details of this process.

There are many advantages to hiring your kids. But first you must have a business to take advantage of the tax benefits. If you are in private practice as a solo practitioner, you are set, as you or your spouse must be the only employer to get the best tax advantage of this situation. You can hire them to work in the office, clean the office, or do yard work on the office property.

If you are an employed physician, you cannot hire your children at work, only your employer can. In that case, you can buy a rental property and that business can hire your children and write off the expense.

Before hiring your kids review the tax rules the IRS has established for hiring your children. These rules can be found here. The good rules are as follows; the parents must be the only owners of the business, if the child is under age 18 you will not have to pay social security or Medicare taxes, and if the child is under the age of 21, you will not have to pay unemployment taxes. 

You can see how this could be of great advantage to you. You can hire your child without paying payroll taxes and you can deduct their wage from your business. You also get to do an activity with your child, teach them good work ethics, and give them financial lessons on handling the money they earn. You can also shift money from your high income tax bracket to their zero percent tax bracket.

Today I will talk about how to hire your children and not get into trouble with the IRS when taking your tax deductions. Next week, I will cover the effect of the tax deductions as well as how you can fund your child’s Roth IRA with this income, setting them up to have millions of extra dollars in their retirement years.

1: You must have a business, but it cannot be a corporation

For you to pay your child and write it off, you must have a business. For us, we hired our children to work in our real estate business. If you do not have your own business currently, then start one. Owning a rental property is a great way to have a business and take advantage of hiring your kids, as well as many other business benefits. Payroll expense, the money you pay your child, is a write off for the business. Corporations have different rules, you can still hire your children but since the corporation is hiring them and not their parents, payroll taxes are owed.

2: Get an employer identification number (EIN)

Any business that has employees will need to have an EIN for payroll purposes. You will need to run your child through payroll even though neither you nor they will owe any payroll taxes. This is a formality to keep their employment proper in the eyes of the IRS. 

3: Hire them for legitimate age appropriate work

There are many jobs kids can do in a business. If you hire them in your medical practice, they can open mail, file, clean and do yard work, to name a few things they are qualified to do. For your real estate business they can do those things plus help you with room turn overs, small repairs, recording rent checks and any other age appropriate task. If you are doing a big repair job, they can be hired as an assistant for the work. The work must be for the benefit of your business. You can’t, for example, have the business pay them to cut your own grass, claiming it gave you more time to work in the business. Some people who have an online business pay their children to be models for pictures they use online. Modeling can be done at any age. 

4: Follow child labor laws

There are special rules for hiring children that regulate the number of hours and what work they can do. Read those government restriction here. Take note, children must not work more than three hours on school days and kids aren’t allowed to do hazardous work. 

5: Pay them an appropriate wage

A good place to start for small children is the current minimum wage. As they get older and more experienced, you could pay them more. But you cannot exceed the rate you would pay a non-family member. For example, if you hired your child to do yard word at the property, you cannot pay them $60 an hour if you could hire a grounds keeping company for $20 an hour. Pay your kids the same as you would have paid someone else with their experience level to do the same job.

6: Do the paperwork

When you have an employee you must have a paper trail. Use the same trail with your kids. Have them sign an employment agreement spelling out what their duties are and how much you will pay them. They should also fill out a W-4 to set their tax withholding figures and a W-9 to put their social security number on file with your business. If you are audited, these forms help establish your child as a legitimate employee.

7: Pay with a check

Never pay your children with cash. Paying with cash doesn’t leave a paper trail, so there is no way to prove they earned income. Write a check out of the business bank account and have them deposit the check, not cash it, into their own bank account or Roth IRA account. This proves they got paid and how much they were paid.

8: Help them file a tax return every year

They will not likely owe any income taxes if their earned income is below $12,000 a year, but in order to be legitimate, you want proof they earned the money. This will also serve as proof of earned income for their Roth IRA deposit as IRA deposits can only come from earned income.

Employing your children to work for your business is pretty easy. In addition to the tax advantages gained, which I will discuss next week,  there are some non-tangible benefits. Teaching them good work ethics at a young age will have many benefits throughout their lifetime. They will also learn how to handle their money well before they are on their own which hopefully will prevent them from having future financial troubles.