Hire Your Kids, Slash Your Taxes, Grow Your Legacy

Aug 8

Written By T Anzi

Family Employment Tax Strategies: A Comprehensive Execution Plan

Small business owners with young families have a unique opportunity to implement powerful tax strategies by employing family members. Based on extensive research and tax planning principles, this comprehensive execution plan outlines how to implement these strategies while staying compliant with IRS regulations and maximizing tax savings potential.

Strategy Overview and Benefits

The family employment approach centers on shifting income from higher tax brackets to lower ones while providing legitimate work opportunities for family members. This strategy can create what tax professionals call a "triple tax shelter" - benefiting the business through deductions, the family member through lower tax rates, and potentially eliminating certain payroll taxes altogether.

Key Benefits Include:

Income Tax Savings: Shift income from your higher tax bracket (24-37%) to your child's lower bracket (0-12%)
Payroll Tax Exemptions: Save up to 15.3% on FICA taxes for children under 18 in sole proprietorships
Business Deductions: Wages paid are fully deductible business expenses
Retirement Jumpstart: Enable children to contribute to Roth IRAs with earned income
Educational Benefits: Build work ethic and real-world skills

Strategy 1: Hiring Minor Children (Ages 7-17)

Tax Benefits

For children under 18 working in a parent's sole proprietorship or partnership (where both parents are partners), wages are exempt from Social Security, Medicare, and federal unemployment taxes. This exemption can save over $3,000 annually on a $20,000 salary.

Implementation Steps

Phase 1: Legal Foundation (Weeks 1-2)

Verify Business Structure: Ensure your business operates as a sole proprietorship, single-member LLC, or partnership between spouses. S-Corps and C-Corps don't qualify for payroll tax exemptions.
Create Job Descriptions: Develop age-appropriate job descriptions that detail:
- Specific duties and responsibilities
- Expected hours per week
- Skills required
- Reporting structure
Research Market Rates: Determine reasonable wages for similar work in your area. Document your research for IRS compliance.

Phase 2: Documentation Setup (Weeks 2-3)

Employment Agreement: Create written employment contracts specifying:
- Job title and duties
- Work schedule and hours
- Compensation rate
- Employment duration
- Performance expectations
Obtain Forms: Collect completed W-4 and I-9 forms from each child.
Establish Record-keeping System:
- Time tracking sheets or digital time clock
- Task documentation logs
- Payment records
- Bank account setup for the child

Phase 3: Payroll Implementation (Week 4)

Get EIN if Needed: Apply for Employer Identification Number if you don't have one.
Set Up Payroll System: Use payroll software or hire a provider to ensure compliance.
Create Payment Schedule: Establish regular pay periods (weekly, bi-weekly, or monthly).

Age-Appropriate Job Examples

Ages 7-10: Filing, organizing supplies, simple data entry, light cleaning
Ages 11-14: Social media management, customer service support, inventory management
Ages 15-17: Marketing assistance, bookkeeping support, project coordination

Compliance Requirements

Maximum Annual Tax-Free Income: Up to $14,600 (2024 standard deduction)
Additional IRA Contribution: Up to $7,000 annually to Roth IRA
Record Retention: Keep all employment records for at least 4 years
Labor Law Compliance: Verify state-specific child labor requirements

Strategy 2: Family Management Company for S-Corps

When to Use This Strategy

If your primary business operates as an S-Corporation or C-Corporation, you'll need to establish a separate entity to capture the payroll tax exemptions for hiring children under 18.

Implementation Steps

Phase 1: Entity Formation (Weeks 1-2)

Create Family Management Company:
- Form as sole proprietorship or LLC (disregarded entity)
- Apply for separate EIN
- Open dedicated business bank account
- Choose appropriate business name (avoid using "Family Management Company" in official documents)
Establish Service Agreement:
- Create contract between S-Corp and Family Management Company
- Define services to be provided (administrative, payroll processing, back-office support)
- Set reasonable management fees (typically 10% markup over employee costs)

Phase 2: Employment Structure (Weeks 2-3)

Hire Children Through FMC: The Family Management Company employs the children as W-2 employees.
Service Delivery: Children perform work for the S-Corp through the management company arrangement.
Payment Flow: S-Corp pays management company → Management company pays children.

Benefits and Considerations

Payroll Tax Savings: Maintains exemption from FICA taxes for children under 18
Income Shifting: Achieves same tax benefits as direct employment
Additional Complexity: Requires maintaining separate entity and additional documentation
Higher Administrative Costs: More complex structure requires careful record-keeping

Strategy 3: Spousal Employment with Section 105 Medical Plan

Medical Expense Reimbursement Strategy

Hiring your spouse enables implementation of a Section 105 medical reimbursement plan, allowing tax-free reimbursement of family medical expenses while creating business deductions.

Implementation Steps

Phase 1: Employment Setup (Weeks 1-2)

Define Spouse's Role:
- Create legitimate job description with real business functions
- Set reasonable compensation based on market rates
- Establish regular work schedule
Documentation Requirements:
- Employment agreement
- Time tracking system
- Performance evaluation process

Phase 2: Section 105 Plan Creation (Weeks 2-4)

Plan Document Creation:
- Written plan describing coverage limits
- Eligible expenses (IRC Section 213(d) medical expenses)
- Claim submission procedures
Eligible Expenses Include:
- Health insurance premiums (if after-tax)
- Medical, dental, vision care costs
- Long-term care premiums
- Medicare and Medigap premiums

Key Requirements and Limitations

Business Structure: Works best with sole proprietorships and single-member LLCs
Employee Limitation: Optimal with spouse as only employee due to non-discrimination rules
HSA Compatibility: Not compatible with HSAs unless structured as post-deductible HRA
Annual Savings Potential: $4,000-15,000+ annually depending on medical expenses

Strategy 4: Section 127 Educational Assistance Plans

Student Loan Repayment Benefits

Provide up to $5,250 annually in tax-free educational assistance to adult children (age 21+) who work for your business.

Implementation Requirements

Written Plan Document: Must establish formal Section 127 educational assistance program
Employee Independence: Child must be tax-independent and at least age 21 to avoid ownership attribution rules
Non-discrimination Compliance: Plan must not favor highly compensated employees

Eligible Expenses

Student loan principal payments (not interest)
Tuition reimbursement
Educational materials and supplies
Job-related training courses

Strategy 5: Solo 401(k) Enhancement with Spouse

Doubling Retirement Contributions

When both spouses participate in the business, contribution limits double from $70,000 to $140,000 annually (2025 limits).

Implementation Steps

Verify Spouse Eligibility: Spouse must have legitimate earned income from the business
Amend Existing Plan: Add spouse to current Solo 401(k) or establish new plan
Separate Accounts: Each spouse maintains individual contribution limits and investment accounts

Critical Compliance Requirements

Documentation Standards

Employment Records Must Include:

Written job descriptions and employment agreements
Detailed time tracking and task logs
Regular performance evaluations
Proper W-2 and tax filing

Reasonable Compensation Requirements

The IRS scrutinizes family member compensation to ensure it reflects legitimate business value. Document market research showing comparable wages for similar positions in your industry and geographic area.

Record-Keeping Requirements

Maintain employment records for at least 4 years after filing the 4th quarter return. Records should include:

Employee identification information
Wage payment dates and amounts
Time worked documentation
Tax withholding and payment records
Benefits provided documentation

Implementation Timeline and Action Steps

Immediate Actions (Month 1)

Business Structure Assessment: Determine if current entity structure supports desired strategies
Family Member Evaluation: Assess which family members can provide legitimate business services
Wage Research: Document market rates for positions you plan to create
Professional Consultation: Meet with a professional to review your specific circumstances

Short-term Implementation (Months 2-3)

Create Documentation: Draft employment agreements and job descriptions
Set Up Systems: Implement time tracking and payroll processing
Establish Bank Accounts: Open separate accounts for family member wages
Begin Employment: Start with small hours to test systems and compliance

Long-term Optimization (Months 4-12)

Scale Operations: Increase hours and responsibilities as appropriate
Add Strategies: Implement Section 105 or 127 plans if applicable
Monitor Compliance: Regular review of documentation and procedures
Tax Planning: Work with tax professional for year-end planning and optimization

Risk Management and Common Pitfalls

Major Compliance Risks

Unreasonable Compensation: Paying significantly above market rates
Inadequate Documentation: Failing to maintain proper employment records
Age-Inappropriate Work: Assigning tasks unsuitable for child's age and capabilities
Irregular Payment Patterns: Paying large lump sums instead of regular wages

Best Practices for Success

Treat family members exactly like other employees
Maintain arm's length business relationships
Document all business justifications for employment decisions
Regular compliance reviews with qualified tax professionals
Photograph children performing work duties for additional documentation

Estimated Financial Impact

Based on implementation of multiple strategies, a family business could achieve:

Annual Tax Savings: $8,500-33,600 depending on strategies implemented
Payroll Tax Elimination: Up to $3,060 annually per child under 18
Medical Expense Deductions: $4,000-15,000 annually through Section 105 plans
Retirement Savings: Up to $140,000 annual tax-deferred contributions with spousal Solo 401(k)

Conclusion

Family employment strategies represent powerful tax planning opportunities for small business owners with young families. Success requires careful planning, meticulous documentation, and ongoing compliance monitoring. While the potential tax savings are substantial, the strategies must be implemented correctly to withstand IRS scrutiny and provide legitimate business value.

The key to successful implementation lies in treating these arrangements as genuine business relationships rather than family financial planning. When executed properly, these strategies can provide significant tax benefits while teaching valuable life skills to the next generation and strengthening the family business foundation.

Critical Success Factors:

Legitimate business purpose for all family member roles
Comprehensive documentation of all employment arrangements
Regular compliance reviews and professional guidance
Market-rate compensation based on documented research
Proper payroll and tax reporting procedures

Sources

T Anzi

Hire Your Kids, Slash Your Taxes, Grow Your Legacy

Family Employment Tax Strategies: A Comprehensive Execution Plan

Strategy Overview and Benefits

Strategy 1: Hiring Minor Children (Ages 7-17)

Tax Benefits

Implementation Steps

Phase 1: Legal Foundation (Weeks 1-2)

Phase 2: Documentation Setup (Weeks 2-3)

Phase 3: Payroll Implementation (Week 4)

Age-Appropriate Job Examples

Compliance Requirements

Strategy 2: Family Management Company for S-Corps

When to Use This Strategy

Implementation Steps

Phase 1: Entity Formation (Weeks 1-2)

Phase 2: Employment Structure (Weeks 2-3)

Benefits and Considerations

Strategy 3: Spousal Employment with Section 105 Medical Plan

Medical Expense Reimbursement Strategy

Implementation Steps

Phase 1: Employment Setup (Weeks 1-2)

Phase 2: Section 105 Plan Creation (Weeks 2-4)

Key Requirements and Limitations

Strategy 4: Section 127 Educational Assistance Plans

Student Loan Repayment Benefits

Implementation Requirements

Eligible Expenses

Strategy 5: Solo 401(k) Enhancement with Spouse

Doubling Retirement Contributions

Implementation Steps

Critical Compliance Requirements

Documentation Standards

Reasonable Compensation Requirements

Record-Keeping Requirements

Implementation Timeline and Action Steps

Immediate Actions (Month 1)

Short-term Implementation (Months 2-3)

Long-term Optimization (Months 4-12)

Risk Management and Common Pitfalls

Major Compliance Risks

Best Practices for Success

Estimated Financial Impact

Conclusion

Critical Success Factors:

The Value of Financial Literacy from a Young Age: A Guide for Parents of Children Ages 11-18