One of the biggest advantages of owning a small business is flexibility – not just the flexibility of being your own boss and managing your business the way you see fit, but also flexibility in managing your tax experience.
Two strategies that can offer meaningful tax and financial benefits are hiring your children and spouse as employees. When done correctly, this can reduce taxes and keep more of your income within your household.
Hiring Your Children
Hiring your children can be a smart way to shift income from your higher tax bracket to theirs – often at little or no tax cost. Because children typically earn below the standard deduction threshold, their income may be tax-free.
Example:
Suppose a business owner in the 37% bracket pays three children $12,000 each (for legitimate work).
- Each child owes no income tax (the wages are below the standard deduction).
- The parent moves $36,000 of income out of the 37% tax bracket.
- That’s a federal tax savings of over $13,000, not counting state taxes.
- As an added benefit, the children now have earned income. This allows them to contribute to a Roth IRA, creating an early start on tax-free retirement savings.
Employment Tax Rules
If a child under 18 works for a sole proprietorship owned by a parent, or a partnership owned solely by both parents, their wages are exempt from Social Security, Medicare, and federal unemployment taxes.
(Once they turn 18, FICA taxes apply, but unemployment tax does not until age 21. And – these exemptions don’t apply to S corporations, though hiring your child through an S-corp might still be worthwhile if the income tax savings outweigh the payroll tax costs.)
Important Things to Remember:
- The work must be real and age-appropriate.
- It is crucial to keep clear records—timesheets, job descriptions, and payroll documentation.
- The pay must be reasonable for the services performed.
Younger kids might handle light administrative work, while teens could help with social media or customer support. The important part is that the work is legitimate and paid fairly.
Child Labor Rules
Federal labor laws are flexible for family businesses. Children of any age can work in a parent-owned business as long as the tasks aren’t hazardous. That means even young kids can help out, provided the work is appropriate and properly documented.
Hiring Your Spouse
Hiring your spouse doesn’t usually reduce your income taxes directly, since you’re likely filing jointly. But hiring your spouse can open several indirect tax benefits that can make it worthwhile.
1. Retirement Plan Contributions
Once your spouse is officially an employee, they can participate in your business’s retirement plan. They can defer part of their wages into a 401(k) or similar plan, and the business can make matching or profit-sharing contributions. Those contributions reduce the business’s taxable income and increase family retirement savings.
2. Health Reimbursement Arrangements (HRA)
By hiring your spouse, you may also qualify to set up an HRA, allowing the business to reimburse medical expenses—like health insurance premiums, co-pays, and prescriptions—as a deductible business expense rather than a personal one.
This option is available for sole proprietors, partnerships (where both partners are spouses), and C corporations—but not S corporations.
3. Deductible Family Expenses
Hiring your spouse can turn some ordinary household costs into legitimate business deductions.
- Cell phone bills become partially deductible if used for business.
- Travel expenses for business trips can be written off if your spouse has a genuine business role.
Best Practices
To make these strategies effective and IRS-compliant:
- Make sure the spouse or child performs real, necessary work for the business.
- Pay reasonable wages based on the job performed.
- Maintain detailed documentation of employment, hours, and compensation.
- Work closely with a CPA or tax professional to set things up correctly and stay compliant with labor and tax laws.
Final Thoughts
When structured properly, paying your children or spouse through your business can:
- Lower taxable income
- Create retirement savings opportunities
- Convert personal costs into deductible business expenses
- Teach valuable financial and work lessons to younger family members
These strategies work best when documented carefully and guided by professional advice. Yet, for many small business owners, they can be a powerful addition to a well-rounded tax plan. As always, contact a financial professional or tax advisor for advice on your specific situation.
