Your best employees may be your relatives, but not your cousin Sue or brother-in-law Ed. Your children can work for you and you don't have to pay unemployment taxes or withholding taxes for them, but you still get to deduct their wages as a business expense. Your children gain job experience and money they can put toward college or buying that pony your youngest has always wanted. The Internal Revenue Service has given its blessing to this scheme, as long as you follow a few simple requirements.
Small Business Owner
To take advantage of this plan, you must be a small business owner and the business must be a sole proprietorship or an LLC — not an S Corp or a C Corp. You don't have to adhere to child labor laws that prohibit children under 16 from working, unless your business is a hazardous occupation such as mining or manufacturing. Your 10-year old can file papers in your office and your 14-year old can answer the phone.
You don't have to withhold social security and Medicare tax or income tax from your child's wages, as long as your child is under 18. Your child will owe tax on any income that's over the standard deduction. In 2010 the standard deduction for a single person was $5,700, so your child will only owe taxes on income earned over this amount. She'll pay this tax when she files the tax return.
Child as Contractor
Another option you have is to hire your child as a contractor to do a specific job for you. This requires a child with a specific skill, such as a teen who can design and maintain a website. You could hire your child to launch a marketing campaign through social media or one with a talent for writing to rewrite all your job manuals. In this case, your child sets herself up in her own business and you pay a set fee for her services. She deducts any expenses incurred in operating her business and pays taxes on any money in excess of the standard deduction. Alan Borsen, a Certified Public Accountant in West Bloomfield, Michigan, proposes this is a great way to pay for your child's college education.
Keep records and issue your child a W-2 at the end of the year. Your child will need to file a tax return. Children must actually perform work and be prepared to provide a list of their job duties to a tax auditor, if audited or asked. If your other employees keep time sheets, then your child should also. The amount you pay your children must be reasonable for the work they do. One good rule of thumb is to pay your child whatever you'd pay a temp to do the same work.