Why This Strategy Works
When your business pays your child a reasonable wage for real work, two things happen simultaneously:
- Your business deducts the wages — reducing your taxable income at your marginal rate (potentially 22%, 24%, 32%, or higher)
- Your child reports the income — but pays tax at their own lower rate, and the first $14,600 (2025 standard deduction) is entirely tax-free
The net result: dollars that would have been taxed at your high marginal rate are effectively shifted to a 0% bracket. For a business owner in the 32% bracket paying a child $14,600 in wages:
- Business deduction saves: $14,600 × 32% = $4,672 in federal income tax
- Child's federal income tax on $14,600: $0 (fully offset by standard deduction)
- Net federal tax savings: $4,672
That same $14,600 can also be contributed to a Roth IRA in the child's name (since they now have earned income), creating decades of tax-free growth.
The IRS Requirements
1. The Work Must Be Real
The IRS will disallow the deduction if the work is fabricated or inflated. Your child must perform genuine services that a business would reasonably pay for.
Legitimate tasks for children by age range:
- Ages 7–11: Shredding documents, light filing, cleaning the office, stuffing envelopes, running errands
- Ages 12–15: Data entry, social media content creation and scheduling, photography for business use, basic bookkeeping under supervision
- Ages 16–18: Customer service, website maintenance, graphic design, video editing, bookkeeping, administrative support
Keep a log or timesheet showing dates worked, hours, and tasks performed. Pay them by check or direct deposit — never cash.
2. The Wage Must Be Reasonable
You must pay a reasonable wage — the same amount you would pay an outside contractor or employee for the same work. Paying your 10-year-old $80,000 to 'help with social media' will not survive scrutiny.
As a benchmark: what would you pay on Upwork or through a staffing agency for the same tasks? Document your reasoning.
3. The Child Must Actually Receive the Money
Paying wages that never actually transfer to the child (paper wages) is tax fraud. The child must have their own bank account, and deposits must be made to it. The child can then spend the money as they wish — including contributing it to a Roth IRA.
The FICA Exemption for Family Businesses
For unincorporated businesses (sole proprietorships and partnerships where both partners are parents), there is a significant payroll tax benefit under IRC § 3121(b)(3):
- Wages paid to a child under age 18 by a sole proprietor parent are exempt from Social Security and Medicare (FICA) taxes
- Wages paid to a child under age 21 by a sole proprietor parent are exempt from FUTA (federal unemployment tax)
This exemption does not apply to corporations (S-Corps or C-Corps) or to partnerships where a non-parent partner exists.
The S-Corp trap: If your business is an S-Corp, you do not get the FICA exemption. Your child's wages are subject to the same FICA withholding as any other employee (7.65% employee side + 7.65% employer side). This reduces — but does not eliminate — the tax benefit of the strategy.
Example comparison (sole proprietor vs. S-Corp, paying a child $14,000):
| Scenario | Employer FICA Cost | Child's Net After FICA Withholding |
|---|---|---|
| Sole proprietorship (child under 18) | $0 | $14,000 |
| S-Corp (child under 18) | $1,071 | $12,929 |
The sole proprietor saves more because there is no FICA at all. But even the S-Corp owner saves significantly through income shifting.
The Kiddie Tax and Its Limits
The Kiddie Tax (IRC § 1(g)) is designed to prevent wealthy parents from simply shifting investment income to children. Under the Kiddie Tax, unearned income (dividends, capital gains, interest) above a threshold is taxed at the parent's marginal rate for children up to age 18 (or through age 23 if a full-time student).
Crucially, the Kiddie Tax does not apply to earned income. Wages your child earns from working in your business are taxed at the child's own rate — not the parent's. This is what makes the strategy work.
2025 Kiddie Tax unearned income threshold: $2,500 (the first $1,250 of unearned income is covered by the child's standard deduction; the next $1,250 is taxed at the child's rate; above $2,500, the parent's rate applies).
Practical implication: The wages strategy works cleanly. But if you also want to shift investment income to the child, the Kiddie Tax largely blocks it.
The Roth IRA Opportunity
Once your child has earned income, they can contribute to a Roth IRA up to the lesser of their earned income or the annual IRA contribution limit ($7,000 in 2025).
A child who contributes $7,000 to a Roth IRA at age 16 and never contributes again will have, assuming 8% average annual returns:
- At age 30: ~$22,500
- At age 50: ~$104,000
- At age 65: ~$330,000 — all tax-free
If contributions continue through college and into early adulthood, the compounding is dramatic. The Roth IRA is funded with after-tax dollars — since the child pays zero tax on wages within the standard deduction — effectively meaning these contributions entered the Roth IRA tax-free on both ends.
NJ-Specific Payroll and Employment Requirements
New Jersey has its own employment law requirements that apply to businesses with child employees, even family members:
NJ Child Labor Laws
Under NJ Rev. Stat. § 34:2-21, children under 16 must have a working certificate (employment certificate) issued by the school principal or superintendent. Children 14–15 may work in certain businesses with restrictions on hours and types of work.
NJ child labor law exemptions include family businesses — children working for a business owned solely by a parent are generally exempt from the working certificate requirement and many hour restrictions. However, hazardous occupations remain off-limits regardless.
NJ Payroll Taxes
Even if the federal FICA exemption applies, NJ has its own payroll taxes:
- NJ State Income Tax Withholding: Required on all wages paid in NJ, regardless of the child's relationship to the owner. You must withhold NJ GIT from wages and remit to the NJ Division of Taxation.
- NJ Disability Insurance (SDI): Employee contribution (0.14% in 2025) and employer match may apply — consult the NJ DOL for family business exemptions
- NJ Unemployment Insurance (SUI): Family business exemptions may apply for children under 18 working for a sole proprietor parent — confirm with the NJ DOL
Employer Registration
You must be registered with the NJ Division of Revenue and Enterprise Services as an employer (even if your only employee is your child). You will issue a W-2 at year-end and file NJ-927 quarterly payroll tax returns.
Step-by-Step Implementation Checklist
- [ ] Create a written job description with specific duties
- [ ] Determine a reasonable hourly rate (document your market rate research)
- [ ] Set up a timesheet or work log
- [ ] Open a bank account in the child's name
- [ ] Register as an employer with IRS (EIN) and NJ DOL if not already
- [ ] Set up payroll with proper withholding (NJ GIT at minimum; federal FICA if S-Corp)
- [ ] Pay by check or direct deposit — never cash
- [ ] Issue W-2 in January for the prior year
- [ ] File NJ-927 and federal 941 quarterly payroll returns
- [ ] Consider opening a Roth IRA in the child's name
Common Mistakes to Avoid
Mistake: Paying wages without doing payroll. Simply giving your child money and calling it wages does not work. You must go through the full payroll process — withholding, deposits, quarterly returns, and W-2.
Mistake: Assuming the S-Corp FICA exemption applies. S-Corp owners frequently try to use this strategy and assume it works like a sole proprietorship. It does not. S-Corp wages are fully subject to FICA.
Mistake: Inflating wages beyond reasonable market rates. The IRS can reclassify inflated wages as gifts, denying the business deduction and potentially triggering gift tax reporting.
Mistake: Not documenting the work performed. If audited, you need to show what work was done, when it was done, and what the business benefit was.
Frequently Asked Questions
What age can my child start working in my business?
There is no federal minimum age for family businesses under the Fair Labor Standards Act (FLSA) for non-hazardous work. NJ allows children of business owners to work at any age in the parent's business with appropriate restrictions. However, children under 7 or 8 realistically have limited ability to perform work that would withstand IRS scrutiny.
Can I pay my child to work in my home office?
Yes, if the home office is your legitimate principal place of business and the child performs real tasks there. The tasks must be business-related (filing, phone answering, scanning) — not household chores.
Do I need a formal employment contract?
A written job description and employment agreement is strongly recommended for documentation purposes. It does not need to be elaborate — a one-page document specifying duties, pay rate, and hours is sufficient.
How much can my child earn before paying federal income tax?
In 2025, the standard deduction for a dependent is the greater of $1,350 or earned income plus $450, up to the regular standard deduction ($15,000). A child with only earned income pays zero federal income tax on up to $15,000 (the full standard deduction for a single individual — dependents get a special calculation but approximately $15,000 in wages will be entirely offset).
Can I hire my spouse using the same strategy?
Hiring your spouse is legally permissible but does not produce the same FICA exemption available for children. Spouses are subject to full FICA. The income-shifting benefit is also minimal unless your spouse is in a significantly lower tax bracket.
Monaco CPA helps NJ business owners implement family employment strategies correctly — including payroll setup, documentation, and coordination with your estate planning.
