Smart Tax Strategy: Hiring Your Kids and Building Their Financial Future

As a business owner, you're always looking for legitimate ways to reduce your tax burden while building wealth for your family. One of the most powerful yet underutilized strategies is hiring your children as employees or contractors. Not only can this provide significant tax savings, but it also creates an opportunity to jumpstart your kids' financial future through strategic investing.

The Tax Benefits of Hiring Your Kids

Maximum Deduction Limits

For 2025, you can pay your child up to $14,600 without them owing any federal income tax (this is the standard deduction amount). This means:

• Your business gets a full tax deduction for wages paid

• Your child pays zero federal income tax on earnings up to this amount

• You're effectively shifting income from your higher tax bracket to your child's zero percent bracket

Employment vs. Contractor Status

As Employees:

• Must follow legitimate employment practices

• Subject to payroll taxes (though exempt from FICA if under 18 and working for parent's sole proprietorship)

• Eligible for employee benefits

• More paperwork and compliance requirements

As Contractors:

• More flexibility in work arrangements

• Child responsible for self-employment taxes (15.3% on earnings over $400)

• Simpler documentation requirements

• Must meet legitimate contractor criteria

Legitimate Work Requirements

The IRS requires that work performed be:

• Legitimate business tasks (filing, data entry, social media management, cleaning)

• Age-appropriate for your child

• Reasonably compensated (can't pay $50/hour for basic tasks)

• Properly documented with timesheets and job descriptions

Investing Their Earned Income: Custodial Account Options

Here's where the real wealth-building magic happens. Your child's earned income can be invested in various custodial accounts, each with unique benefits:

1. Custodial Roth IRA

Benefits:

• Tax-free growth and withdrawals in retirement

• Contributions can be withdrawn penalty-free anytime

• No required minimum distributions

• Decades of compound growth potential

Limits: Can contribute up to 100% of earned income or $7,000 (2025 limit), whichever is less

Example: If your 16-year-old earns $5,000, they can contribute the full $5,000 to a Roth IRA

2. UGMA/UTMA Accounts (Uniform Gifts/Transfers to Minors Act)

UGMA Benefits:

• Covers financial assets (stocks, bonds, mutual funds)

• Child gains full control at age of majority (18-21, depending on state)

• More investment flexibility than 529 plans

UTMA Benefits:

• Includes all UGMA assets plus real estate, art, patents

• Can specify later transfer age (up to 25 in some states)

• Greater asset protection until transfer

Tax Considerations:

• First $1,300 of unearned income tax-free (2025)

• Next $1,300 taxed at child's rate

• Above $2,600 taxed at parent's rate (kiddie tax)

3. Custodial 529 Education Savings Plans

Benefits:

• Tax-free growth for qualified education expenses

• State tax deductions in many states

• Can change beneficiaries within family

• High contribution limits

Considerations:

• Limited to education expenses (though definition has expanded)

• 10% penalty on non-qualified withdrawals of earnings

4. Custodial Taxable Investment Accounts

Benefits:

• Complete investment flexibility

• No restrictions on withdrawals or usage

• Teaches real-world investing lessons

Drawbacks:

• Subject to kiddie tax rules

• No special tax advantages

Strategic Implementation Tips

Start Early

The power of compound interest is incredible. A $5,000 Roth IRA contribution at age 16, growing at 7% annually, becomes over $150,000 by retirement age 65.

Document Everything

• Keep detailed records of work performed

• Maintain timesheets and job descriptions

• Pay through proper payroll or contractor payments

• Issue appropriate tax forms (W-2 or 1099)

Consider State Laws

• Some states have different rules for custodial accounts

• Workers' compensation requirements may apply

• Child labor laws must be followed

Mix Investment Vehicles

Consider splitting earned income between:

• Roth IRA for long-term retirement savings

• UTMA account for medium-term goals

• 529 plan if college is a priority

Real-World Example

The Johnson Family Strategy:

• 17-year-old Sarah works 10 hours/week at dad's consulting firm

• Earns $12,000 annually at $23/hour for legitimate administrative work

• Contributes $7,000 to Roth IRA

• Invests $3,000 in UTMA account

• Keeps $2,000 for personal expenses

• Family saves approximately $3,600 in taxes annually

Important Considerations

Avoid These Mistakes

• Paying unreasonable wages for simple tasks

• Not maintaining proper documentation

• Having child perform no actual work

• Mixing personal and business expenses

Professional Guidance

This strategy involves multiple areas of tax law, so consider consulting with:

• A qualified tax professional

• Financial advisor familiar with custodial accounts

• Attorney for complex family situations

The Bottom Line

Hiring your children can be a win-win-win strategy: your business gets legitimate tax deductions, your kids learn valuable work skills and financial responsibility, and your family builds long-term wealth through strategic investing.

The key is doing it right from the start – legitimate work, proper documentation, reasonable compensation, and smart investment choices that align with your family's

goals.

This strategy has helped countless families reduce their tax burden while setting their children up for financial success. The combination of immediate tax savings and long-term wealth building through custodial investment accounts makes it one of the most powerful tools available to business-owning families.

Remember: Tax laws change frequently, and every family's situation is unique. Always consult with qualified professionals before implementing these strategies.