As I was closing the store and organizing the cash register, my second child quickly sorted the receipts by date. Watching this made me wonder: what would happen if I officially paid this child a salary?

You've probably heard in meetings with other business owners that hiring your children can reduce taxes. However, few people seem to know exactly why that is or how accurate that statement is.

So, I decided to look up IRS materials and summarize what I found. To cut to the chase, it's true. However, there are quite clear conditions attached.

The first reason is simple. The salary paid to your child is treated as a business expense. This reduces the net profit of the parent's business, lowering the basis for calculating income tax and self-employment tax.

The second reason is key. According to IRS guidelines on family employment, wages paid to children under 18 working for their parent's sole proprietorship are exempt from Social Security and Medicare taxes. Both the employee's and employer's portions are excluded.

Additionally, the federal unemployment tax (FUTA) is also waived for children under 21. This means that if your college-aged child helps out during breaks, this exemption could apply.

The third point concerns the child's income tax. As of 2026, the standard deduction for a single filer is $16,100. Even as a dependent, if the child has earned income, they can deduct up to $16,100, which includes an additional $450 for earned income.

In simple terms, this means that any money the child earns within this range will not incur federal income tax. The parents can deduct it as an expense, and since the child pays little to no tax, income effectively shifts from the higher tax bracket to the lower one within the family.

I was honestly surprised when I first understood this structure. As someone who has been paying self-employment tax at a rate of 15.3% every year, it was astonishing to realize that this is legal.

However, this is where it gets important. These benefits vary significantly depending on the type of business entity. The FICA exemption only applies if you are a sole proprietor or if all partners in a partnership are the child's parents.

If you operate as a corporation, the situation changes. The IRS states that for corporations or partnerships with partners other than the parents, income tax withholding, Social Security, Medicare, and FUTA apply regardless of the child's age.

Many business owners have converted to S corporations, but in this case, expecting a FICA exemption is unlikely. While the expense deduction and the child's standard deduction benefits remain, the savings will be reduced.

Another point is that you cannot just assign any task and pay them. The work must be related to the business and should be a reasonable amount that you would pay someone else for the same job. Household chores like washing dishes or cleaning rooms do not qualify.

There have been cases where excessive salaries paid to a ten-year-old were not recognized as expenses by the tax court. If the amount is unreasonable for their age, it will be hard to justify during an audit.

Therefore, keeping records is crucial. A timesheet documenting the dates worked, hours, and tasks performed is essential. It's also a good idea to create a simple job description.

Instead of handing cash directly, it's cleaner to deposit the salary into the child's account. At the end of the year, you must also issue a W-2 form. Remember that income tax withholding applies regardless of age.

If you are running a store in New Jersey, you should also check with the state government. The federal FUTA exemption does not automatically extend to state unemployment insurance.

The New Jersey Unemployment Insurance Law includes provisions for children under 18 working for their parents. However, there is a condition that the FUTA exemption must also be met, so it's advisable to confirm this with labor department resources or your accountant.

There are also regulations regarding minor employment. Depending on their age, there are limits on the hours they can work and the types of tasks they can perform, so it's wise to review the New Jersey Department of Labor's guidelines on minor employment before assigning tasks.

Some people go a step further. If the child earns income, you can contribute to a Roth IRA within that income limit. The IRA contribution limit for 2026 is $7,500.

Thinking about how a Roth IRA started at age fifteen could grow over decades is quite fulfilling. This might be a bigger gift than just saving on taxes.

While it may seem like a tax-saving strategy, I believe it ultimately serves as education. The experience of interacting with customers, counting inventory, and seeing the amount deposited on payday is something they can't learn in a classroom.

However, one must avoid greed. If you artificially inflate the salary just to save on taxes, it could lead to penalties and interest instead. Paying a reasonable hourly wage for the actual hours worked is the best long-term approach.

The outcomes can vary significantly based on the type of business entity, the child's age, and other sources of income. Since it depends on individual circumstances, it's essential to consult a tax professional before starting.

If it were me, I would first check whether my business is a sole proprietorship or a corporation, then determine what tasks the child can realistically perform, and start using a timesheet from the first month.

Additionally, I would ensure that a portion of the salary is saved in the child's name. Learning to earn and save money together is the real profitable venture.

When I brought this up to my second child, who was organizing receipts, they immediately asked how much the hourly wage would be. Truly a business owner's child. We agreed to negotiate next week.