I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox ๐ Also on YouTube at PlugAccountingandTax!
Paying Your Kids on the Up & Up
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There is no lack of bad advice from tax gurus with (a) no real experience, and (b) no real skin in the game. And one of their favorite "loopholes" is paying your kids to save thousands in taxes. Which sucks because it's given this strategy a stigma where a lot of taxpayers write it off as tax fraud without understanding how it can be done legitimately. Today we'll do just that. Here's the real way to pay your kids, how much tax it saves, and what to avoid. The exemption lives in the entity, not in the paperworkThe big kicker to the strategy runs on one rule most people never hear: wages paid to your child under 18 are exempt from Social Security and Medicare tax, and wages to your child under 21 are exempt from federal unemployment tax. Not deferred. Not reduced. The 15.3% never gets assessed against anybody. ๐งพ The catch is that the exemption belongs to the business, not the child. It applies when the child works for a sole proprietorship, or for a partnership where every partner is a parent of that child. Take in one outside partner, or elect S-corp, or run a C-corp, and the same kid doing the same work now generates full FICA and FUTA from dollar one. Same child, same job, different entity, and the exemption is gone. So before you run payroll for anyone, check what's on the return. This is the step the gurus skip, and it's one that can decide whether the strategy is worth doing at all. What the deduction actually savesYour child gets the full $16,100 standard deduction in 2026 (the dependent limit is earned income plus $450, capped at the regular single amount, so W-2 wages up to that number come in untaxed). Their federal income tax bill on $16,100 of wages: zero. ๐ On your side, take a sole proprietor filing jointly with $150,000 of net profit who pays one child $16,100 for real work:
Two kids at the same number runs close to $9,800. The dollars move from a return taxed at your rate to a return taxed at zero, and the payroll tax on the way out disappears. That's the entire mechanism. No trust, no offshore anything. Caveat - getting "on the money" to the standard deduction can be a red flag under audit. The four things that make it hold upEvery case on this fails on the same four items, and they're all things you control in advance. ๐ The work has to be real and age-appropriate. Shredding, filing, sorting inventory, cleaning units, stuffing mailers, basic data entry, social media posts they actually make. A 7-year-old "consulting on marketing strategy" is the fact pattern that gets the whole thing thrown out. Don't get me started on $16k for "headshots" of your 1 year old. The pay has to be what you'd pay a stranger. If you'd hire a neighbor's kid at $15 an hour to do it, your child gets $15 an hour to do it. $16,100 divided by $15 is about 1,073 hours, which is real part-time work over a year. If your child can't put in the hours, they don't get the number. Run it through actual payroll. Timesheets with dates and tasks, a real pay schedule, a W-4, a W-2 at year end, and income tax withholding handled correctly (if you're not using Schedule C or Parent Partnership). The FICA exemption does not exempt you from being an employer. The money has to reach the child. Their own bank account, their name on it. Money that lands in your checking account and pays your mortgage was never their wage. Once it's theirs, you can direct it toward their expenses, a custodial Roth IRA (up to $7,500 in 2026, and the wages are what make them eligible). Pitfalls based on real Tax Court casesThe Tax Court has been ruling on parents paying their kids for decades. Here's a few good ones to spot check pitfalls โ๏ธ The one the strategy is built on: Eller (1981). The Ellers ran mobile home parks and paid their three children, ages 12, 11, and 7, a total of $17,697 over three years. The IRS called 90% of it unreasonable. The court allowed $15,547 of it, about 88 cents on the dollar, and the reason is in the facts: the kids maintained the swimming pool, read the gas and electric meters, mopped the laundry room, swept trailer pads, registered transient tenants, and collected the nightly rentals. The court found that if the children hadn't done that work, a third party would have been hired to do it. Dad also testified that he promoted the kids as they demonstrated aptitude, and pay went up with responsibility. The court still trimmed the 7-year-old's share, noting that 11 and 12 year olds "can generally handle greater responsibility and perform greater services than 7-year old children." Real jobs, real ladder, mostly upheld. The one that kills the shortcut: Denman (1967). Sole proprietorship run out of the house, three sons ages 7 to 11, $520 each, and the father deposited the money into bank accounts in the children's names. That's the step everyone online tells you makes it bulletproof. The court called the work (yard work, window washing, stuffing envelopes) "parental training and discipline" rather than employment, and out of roughly $1,560 claimed in 1960 it allowed $185. The modern version: Alexander (2006). Four children, $16,750 in wages, and actual paperwork: a list on the refrigerator, an hourly summary, a document titled "1998 Timesheet." All of it disallowed. No employment tax filings, no W-2s, no 941s, the amounts were fixed at the start of the year instead of tracking work performed, some payments landed before the work and some after, and the tasks included walking the family dogs. Documentation created to support a number you already picked reads as exactly that. The TakeawayPaying your kids is a real strategy with a specific shape. Sole proprietorship or a parent-only partnership, child under 18, real work at market pay, actual payroll, and the money lands in their account. Done that way, one child moves about $4,900 a year from taxable to not, and the Trump Account adds $2,500 more that never gets taxed on the way in. Done the way it gets sold on social, it's a deduction with no work behind it, which is the definition of the thing everyone's afraid it is. If you're in an S-corp or a partnership with outside partners, the exemption isn't available to you as-is, but adding in additional entities could help you get there. I'm a CPA, but (for the majority of you) not your CPA. Run your specific facts past your own advisor before you put anyone on payroll. Curious about what other strategies we use when working with clients? Build your own gameplan here. ๐ซก Group Chat Worthy Posts ๐ฅ๐ฒ
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The Plug [Newsletter]
I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox ๐ Also on YouTube at PlugAccountingandTax!
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