*Editor’s Note: This blog has been updated as of May 9, 2022 for accuracy and comprehensiveness.

Need extra help this summer? Consider hiring your teenager or 20-something who’s off from school. Not only will this provide a meaningful and financially rewarding activity for your child, but it can also provide you with tax benefits, especially given challenges that came with COVID-19.

How does this work?

Thanks to the TCJA, the standard deduction was nearly doubled and is now $12,550 for a single filer. So, if you hire your child, you can pay them as much as $12,550 this summer. When your child completes their tax returns, they will be able to net that income against the standard deduction, hence no taxable income! Your child’s income could also be exempt from social security, Medicare, and the federal unemployment tax as well (if you operate as a sole proprietorship, limited liability company treated as a sole proprietorship, a husband-wife partnership or a husband-wife LLC treated as a partnership.)

Your business can also deduct the wages as a business expense if the work is legitimate and the child’s wages are reasonable.

What is considered legitimate work?

As a general rule, the Fair Labor Standards Act (FLSA) sets 14 years as the minimum age for employment, but this does not apply to minors employed by their parents or legal guardian. Of course, it is likely that many jobs that families need to fill for the summer require the maturity of a child age 14 and up. You’ll also need to comply with child labor laws, which vary state to state.

Children need to be assigned reasonable responsibilities—light warehouse duties, filing work, database tasks etc.

What are considered reasonable wages?

The IRS stresses that wages paid to family members cannot exceed the fair market value (FMV) of the services actually performed by the family member. Don’t run into a situation where you’re paying your child more than someone else would earn in the same position, or giving them special privileges (leaving early, coming in late, etc.).

Picture this…

Let’s say Phil, a restaurant owner who is in the 37% tax bracket, hires his 19 year old daughter, Lily to work full-time as a waitress for her 4 month break before she returns to college in the fall. This is her only job for the summer, and she earns $12,550. Lily can use the standard deduction to completely shelter her earnings, and Phil will save $4,644 in income taxes at no cost to his daughter.

What about an IRA for your kids?

An added benefit in the example above is that Lily can also now contribute to her own traditional individual retirement account (IRA). Contributions to an IRA are limited by the lesser of earned income or $6,000 ($7,000 if over age 50). If Phil paid Lily a total of $18,550, the first $12,550 would be reduced by the standard deduction and the next $6,000 would be offset by a $6,000 IRA contribution deduction and Phil would be able to take a deduction saving him upwards of $6,864 in taxes on his personal return.

How does the “kiddie” tax factor in?

Check out our blog, Old Kiddie Tax Rules Reinstated. Thanks to the SECURE Act, the kiddie tax rules have now been reversed back to the rules before the TCJA. Therefore, the first $1,100 of unearned income is covered by the kiddie tax’s standard deduction and is not taxed. The next $1,100 is taxed at the child’s tax rate (either 0% or 12% -- $12% if over $9,950)

Note that the kiddie tax does not apply to earned income, so parents/employers and children/employees need not worry about its impact on this scenario.

Need guidance on this and other family-related tax saving strategies? Contact us!