As a parent entrepreneur, you might be considering hiring family members to work in your business. It’s a great way to build wealth for the entire family, but if your business is structured as an S-Corp, there are certain limitations and rules you need to follow. Understanding these limits will help you maximize tax benefits and avoid surprises at tax time.
1. Reasonable Compensation for Family Members
The IRS requires that any family member you hire in your S-Corp be paid a “reasonable” wage for the work they do. What does this mean? Essentially, the wage must reflect what you would pay a third party for the same job.
For example, if you hire your child to do office work, the wage should align with what an entry-level office worker would earn. Failing to pay a reasonable wage could lead to tax penalties.
2. Self-Employment Taxes: Wages vs. Dividends
As an S-Corp owner, you can distribute profits from the business as dividends, which are not subject to self-employment taxes. However, any wages paid to yourself or family members are subject to payroll taxes, including Social Security and Medicare.
It’s important to keep this in mind when you structure your pay. The goal is to pay reasonable wages while also taking advantage of the tax-free dividends.
3. Age-Appropriate Work for Kids
If you’re thinking about hiring your kids in your S-Corp, be mindful of the tasks they can perform. The IRS has specific guidelines about what constitutes “age-appropriate” work. Children under 18 cannot do jobs that are hazardous, and the work they perform must be legitimate tasks that benefit the business.
For example, your 12-year-old can help with office organization or data entry, but they can’t handle heavy machinery or complex tasks that aren’t age-appropriate.
4. Other Considerations When Hiring Family in an S-Corp
There are other factors to keep in mind when hiring family members in your S-Corp:
- Payroll Compliance: You’ll need to ensure that you’re complying with payroll taxes, making timely filings, and issuing W-2s.
- Retirement Contributions: If you hire your spouse or kids, they may be eligible for retirement plan contributions, such as IRAs or 401(k)s, which could help boost their future savings.
Conclusion:
Hiring your family in your S-Corp is a smart tax strategy, but it comes with some important limitations. By understanding the rules and paying reasonable wages, you can maximize tax savings and ensure your business complies with IRS regulations.
