Transcription
You're already paying for your kids' food, clothes, sports, and phones out of after-tax dollars. But what if your business could pick up part of the tab, and the IRS helped fund it? Well, today I'm going to show you how to legally put your kids on payroll so you can lower your personal tax bill, build wealth, and keep the audit risk low. All right, let's get started.
Okay, so what do I, what am I talking about here? Look at business owners, real estate investors. We already know the game. The tax code rewards people who act like employers and investors. One of the most understood moves in the playbook is hiring your own kids into your business. And I get it because I grew up in a real estate investor family, and my father, who had advisors, never once told him this strategy. He could have saved thousands of dollars if he had had this information. When I was growing up, because he could have taken that money and paid us with this strategy I'm going to share with you, and could use that to fund my college education with pre-tax dollars. I'm going to walk you through exactly what my father should have been doing, and how you can use your business, or if you have an existing business, what changes you need to make if it's not set up the right way to make sure you can realistically pay them money and get a full deduction for it, and they won't have to pay taxes on it. And you can avoid an IRS audit, or at least not have to panic if they do question it.
Okay, so what are we for looking at that? So most parents today pay their kids, right? We just don't do it the right way. We do it the expensive way. We buy them shoes, we buy them their sports gear. We have summer camps and phones and computers and video games and all that stuff. And the way we do it is we earn money in our business, it flows to us, we pay taxes on it, and then we take that tax, or that after-tax money, and we use it to spend on our kids. The problem with that is that we're often in a much higher tax bracket, right, than our children. So what we need to do is figure out a way to get money to flow down to them, to have it taxed in their tax bracket. And if you do it the right way, it'll be tax-free.
So when you hire kids into the business the right way, two things happen. First, your business gets a tax deduction for their wages, of course, as an ordinary and necessary business expense under section 162, just like any other employee. Second thing is, is that the money shows up on your children's tax return, right, at their tax brackets, which are typically way lower than yours. And in most situations, depending on how you're doing this, it's going to be zero when you keep it under their standard deduction for the year. So let's take for 2025 for example, your dependent standard deduction is either the greater of $1,350 or their earned income plus $450, up to the regular standard deduction for their filing status. So for a kid with only wages and no investment income, that means you can pay them several thousand dollars a year, and they'll have no federal income tax while your business is writing this off. So rather than being taxed down to you at your much higher rate, like my father used to do, collect income, pay tax on it, let's say 30%, and then use what was left to pay for our clothing and things like that. What it should have been doing is paying it to us directly, allowing us to collect that money at a lower, no tax bracket, and make us buy our own clothing. This is called income shifting. This is what the wealthy do to move money out of their higher tax bracket, down into their, down into a lower tax bracket, and it's a core move that anyone that is involved with anything, you know, real estate investing or any businesses should be aware of, to make sure you're lowering your taxes to the greatest extent as possible.
Now, I've been talking really fast here and about a lot of different things. So let me just break this down and slow it down for you and explain to you the tax side. Okay. So on the income tax side, the IRS says that if your child is a separate taxpayer, which they are, if they have earned income from actually working in a business, then they have to file their own tax return. And you can look this up and verify in Publication 929 and Topic 551. It lays out all the filing rules for dependents and their standard deduction formula. So picture this, right? Let me just go here and we'll draw out the picture. So your LLC, so let's say I have a limited liability company here. Here's my LLC. And here's my kid right here. So this child is 15. Oh, by the way, I'm talking about children that are under 18 years of age, right? Not people who are older, over 18 years of age. Okay. So let's say that your LLC pays your 15-year-old $10,000 this year, all right, to help with legitimate work. Now, I'll explain what I mean by legitimate work in a little bit. So if I had earned $30,000 from this business, and now I'm paying my child $10,000, that is a deduction to my business. So I only have $20,000 in profit left over. So if I was in, say, a 30% tax bracket, me as the parent, then by moving that $10,000 out of my business, that's $10,000 that's not going to be taxed to me. So what does that save me? Well, by moving the $10,000 out, I just saved $3,000 in federal income taxes at my 30% tax bracket. Now, some of you may be saying, well, Clint, well, what about the child? They got to recognize the $10,000. That's true. So the child picks up the $10K, and the child will file a tax return. But the child's standard deduction of $15,007.50 means that they can make up to that amount of money completely tax-free. So this is completely wiped out. So they make $10,000 with zero tax. That's the strategy right there. You're shifting money from your tax bracket to your child's tax bracket in order to reduce your federal income tax bracket. That's $3,000. Let's think over ten years, okay? That could be $30K that you could be moving over to your child. Okay. And if they took that $30,000 and they put it into a Roth, well, we'll talk about that in a moment, okay?
So let's go on. Now, the one thing that comes up here whenever I mention this strategy is some of the more savvy individuals who have heard about this in the past but didn't really put the pieces together, always throw out an objection. And that is payroll taxes. Okay. Let's say, well, yeah, Clint, but if I do that, I'm going to have to set them up on payroll, and we're going to have to pay payroll taxes on top of this salary that I'm paying them. Well, wait a minute. Payroll taxes will only apply in certain situations. They don't apply in every situation. When you're paying your child, the IRS has special rules for family employees. So if your child works in a sole proprietorship or in a partnership where each partner of the partnership, so this LLC is set up with my wife and I, and it's treated as a partnership for federal tax purposes. So if each parent is a partner in that partnership, then the money that we pay the child, so either from a sole proprietor that can be a disregarded LLC, or just a, you're a Schedule C wage earner, or from an LLC, it's treated as a partnership. The salary that we pay them, if they're under 18 years of age, okay, then it's not subject to Social Security and Medicare taxes. Okay. Now that's huge, right? You're saving both the employer and the employee side of FICA on top of the income tax arbitrage that I just laid out for you. Now, if your business, in which many small businesses are set up as S-corps or C-corporations, then it doesn't work. So if you have an S-corp or a C-corp in your business and you want to engage in this strategy, then you have to be aware of the fact that you will be subject to those taxes, those employment taxes on the payroll. But there's a way to get around that as well, and I'll show you that. So the benefit here, though, in doing that, even if you didn't get around it and didn't follow what I'm about to share with you, you're still saving money because the employment taxes here, let's say they're $1,500, you're still saving the income tax on that. So even if I didn't benefit from the employment tax savings, I still benefited from the income tax savings because if it was my business, S-corp or C-corp, and I was taking that out as the salary, I would have to pay it unless I had already maxed it out. So there's massive savings that can be done here when you set this up the right way.
So what is the strategy to help those of you who are watching this? You're thinking, this is great, but I'm an S-corp or a C-corp. How do I get the benefit? Because I want to eat the whole thing. I don't want to pay any tax. I get you. So here's what you need to do. Let's say you've got your, your S-corp or your C-corp. Here's my LLC, and it's treated as an S-corporation for federal tax purposes. And I want to employ my child. Let's say I flip real estate and I'm running it through this business. What you need to do is you need to set up a second business over here, okay? Set up another LLC and treat this one as a disregarded entity, okay, disregarded for federal tax purposes, and make it a manager of this entity here. Okay. So this entity, your business will pay this company here to manage it or perform some type of task for it. Maybe it's going to do the marketing of your properties, right? Just figure out what this activity is, but set up an LLC as a disregarded entity. Because remember I talked about this earlier when I went through this scenario here, and I said, in order to avoid the employment taxes, there were two things you had to do, right? One was be a sole proprietor, a disregarded LLC, an LLC that's treated as a disregarded with one owner is a sole proprietor for federal tax purposes, or it needs to be a partnership. So what we're doing is we're creating this scenario where we have the proper type of entity. So now this company here, the $10K, rather than pay my child directly the $10K and employ it through my S-corp, instead, what I'm going to do is I'm going to pay the LLC the $10,000. So I get a deduction here of $10K, and then my LLC is going to pay my child $10K to perform the service that's being performed on behalf of this business for the benefit of this business. By doing it this way, you eliminate the employment taxes, and that's why you're fine with advanced planning. This is what people are doing. This is a real-world strategy here of how they're getting around that, and they're able to move money to their kids by setting up their management company to put this money over there.
Now, what can your kids actually do? Because this is what trips people up when it comes to utilizing this type of strategy that may get them audited. And I've seen all kinds of crazy scenarios out there before. Oh, my, my child picks up staples off the ground and counts paper clips, and I pay him $30 an hour. That's never going to work, right? Especially if it's a three-year-old. They're probably eating more of them than they're actually counting. So when you're hiring your kids, you've got to make sure you document, and it's not a pretend job, okay? And so what you'll see, you know, of course, in the tax code, it talks about ordinary, necessary, reasonable compensation. So for younger kids, six, seven to 12, 11, 12 years old, the work has to be, you know, simple and generally tied to the business. Think of, you know, like cleaning out your short-term rentals or your apartment building. That's what I had to do when I was a kid. Go down to my dad's apartment or rentals and clean them out, helping with mailers, organizing receipts would be something. Stuffing envelopes, filing for your business, computers, work for you. They could probably pick up a draft or going through documents and organize your computer. These types of things that have chore-like job descriptions, they work. Now, if you're going to do that, of course, you want to make sure that you have timesheets that you sign off on, showing how much time your child actually spent doing that particular activity. Because at the end of the day, if you're audited, this is always going to come up.
Now, as they get older, they can do more things for your business. You know, I grew to the point where I was actually going out there and rehabbing properties. And so now you can actually start paying them even more money for their services, and they can work longer hours, of course, as well, because they can drive themselves to the job site. Maybe you don't have that in your business. Maybe it's not in real estate and something else. Here's something that they can be doing. How about managing your social media, editing videos, taking property photos, helping at events, updating your website, managing your inventory, data entry. You know, I employed my children under a similar strategy when they were younger, and I was having them do data entry here at the law firm. I was having to go through files, and we were converting everything from paper into digital. You see, now they're acting like, you know, a part-time employee, part-time marketing assistant, and you're paying them a going rate, which is usually going to be very defensible if you can show what it would cost you to bring in someone else. And so there's reasonable pay there, so you can start moving a lot of money. We're not talking $15 an hour. Depending on your area, maybe, you know, $20 an hour or $30 an hour for that same type of work. And when you start doing that, these numbers really start to grow for you, and you can start moving a lot of money down to them.
So now we're paying our kids to do this stuff. So what's the benefit then? Okay. When they get those funds, well, the idea is, let's say I was paying my child here $15,000 a year to work for my business. Now, that $15,000 is, as I talked about, tax-free. So what do they use that $15K for? Well, part of that is, if you wanted to, you could have them contribute to a Roth IRA. They could move $7,000 into a Roth IRA. So that means that that money, because they have earned income, even though they have to pay employment taxes on a $15K, they can put $7,000 of that into a Roth. Just think over time. If you did that for, say, eight years, and now they're 18, they have $56,000 in a Roth. What would that be worth 30, 40, 50 years from now when they're ready to retire? It's a big number. I would suggest you run the numbers on that, and you're going to be surprised on what that can grow at. If you just invested in the S&P at its average return, what will be there for them? I'm not going to do that for you. YouTube would end up flagging me, say I'm offering up false information because I'm using historical numbers, so you can do those numbers yourself. But I tell you, the numbers can be huge. Now they get $8,000 left over. Where does that go? That can go in an investment account. Or better yet, what you say is now when you want to go school shopping, you can take $500 for clothing, you can buy your clothing and supplies. You use that money also to pay for your college education. And so now we're making the IRS a partner in the raising of our children, the financial burden there, because you're not having to pay taxes on the money they're receiving, and they're taking those funds and they're using them not only to pay for things that you were paying for with after-tax dollars. Now they're pre-tax dollars because there's no tax here, but we're also building a retirement plan for them along the way.
So don't screw this up by having, you know, fake jobs. Make sure you've got the paperwork to back it up, keep track of everything they're doing. The times they worked, of course, is really important. Don't overpay relative to the work, and you're going to have a pretty strong structure here that will allow you now to start tapping into what the wealthy are doing in order to reduce their taxes and maximizing the tax code to their benefit. You're going to be way ahead of your neighbors when it comes to using strategies like this. Make sure you're setting it up the right way.
Hey, if you're listening, you're thinking, okay, I want my kids on payroll, and I don't want to create a tripwire that's going to bring the IRS into my business. Well, that's exactly what my team here at Anderson does all day long. We help business owners and real estate investors structure their businesses or LLCs and their family employment so that the tax benefits are maximized and the paperwork backs it all up. So here's what I'm going to do. Into the show notes, I've got a link for a free strategy session with someone on my team. We'll map out how much you can realistically pay your children and how you would create the structure so you'll feel confident going forward. This can put a ton of money back in your pocket, and now you can start doing what the very successful people are doing to grow their wealth much quicker. Take care, and I wish you the very best with your business and your investments.