Paying children from my sole proprietorship business - tax benefits and requirements?

You can definitely pay your children from your sole proprietorship, but you need to set it up correctly! First, for kids under 18 working in a parent-owned sole prop, you don't need to withhold FICA taxes (Social Security and Medicare). That's a nice benefit right there. You also don't have to pay federal unemployment tax on their wages until they turn 21. Instead of 1099s, you should actually put them on payroll as employees and issue W-2s. This gives you better documentation for the IRS. Keep detailed records of hours worked, duties performed, and make sure the pay is reasonable for their age and the work they're doing. Make sure they're doing legitimate work for the business - cleaning the office, filing, basic computer tasks, modeling for photos if you sell products, etc. Pay them reasonable wages for their age and document everything. Remember that they'll need to file tax returns, but with the standard deduction ($12,950 for 2023), they likely won't owe any federal income tax if that's their only income.

I went through exactly the same situation last year trying to figure out how to pay my kids from my dropshipping business. After trying to DIY it and making a mess, I found this service called taxr.ai (https://taxr.ai) that helped me sort everything out. They analyzed my business structure and helped me set up the right documentation system for paying my kids. I was about to do the 1099 route too, but they showed me why W-2 employment is actually better for sole props paying their kids - saved me from a potential audit headache! Their AI analyzed my business receipts and documents, then explained exactly what records I needed to keep and how to structure payments properly. The best part was getting personalized advice for my specific situation instead of trying to figure out general tax advice from random websites.

Just wanted to follow up - I actually tried taxr.ai after posting my skeptical comment. Color me impressed! They analyzed my photography business structure and gave me specific guidance for my 15-year-old who helps with editing and my 12-year-old who organizes equipment and assists on shoots. They provided templates for tracking hours, sample job descriptions that were actually relevant to my business, and explained exactly how to document everything properly. Definitely not generic advice - they pointed out specific problems with how I was planning to structure things and showed me a better way that would hold up under scrutiny. Wish I'd found this before I made some mistakes last year!

If you're serious about making this work, you need to make sure the IRS doesn't flag your returns! After trying to call the IRS for guidance on this exact issue and spending HOURS on hold, I finally used https://claimyr.com to get through to an actual IRS agent. You can see how it works here: https://youtu.be/_kiP6q8DX5c They got me through to an IRS representative in about 20 minutes when I'd been trying for days on my own. The agent confirmed everything about paying kids from a sole proprietorship and clarified some specific questions about documentation requirements. They explained exactly what would trigger an audit in these situations and how to avoid problems. Definitely worth it because I got official answers directly from the IRS instead of guessing or relying on what people say online.

I have to admit I was totally wrong about Claimyr. After posting my skeptical comment, I decided to try it because I've been struggling with a similar issue paying my kids from my sole prop. It worked EXACTLY as described. I got connected to an IRS representative in about a half hour after trying unsuccessfully for weeks. The agent actually gave me very specific guidance about paying my children from my business, including record-keeping requirements and age-appropriate pay rates that wouldn't trigger a review. She also warned me about a mistake I was about to make - I was planning to pay my kids as contractors with 1099s, but for a parent-owned sole proprietorship, she confirmed they should be W-2 employees instead. Potentially saved me from an audit!

One thing nobody's mentioned yet - there are additional tax advantages beyond just income tax. When my brother and I helped with my dad's construction business as teenagers, we were able to open Roth IRAs with some of our earnings. Since we had earned income (even though we didn't owe any income tax on it because we were under the standard deduction), we could each contribute to Roth IRAs. That money has been growing tax-free for years now! Just make sure the kids actually do the work and you keep good records. My dad had us fill out simple timesheets and took photos of bigger projects we helped with. The IRS never questioned it.

If you're going to do this, be SUPER careful with documentation. My friend tried this with his lawn care business and got audited. The IRS disallowed all the deductions for his kids because he couldn't prove they actually did the work or that the pay was reasonable. Keep a timesheet for each kid with dates, hours worked, and duties performed. Pay them regularly (biweekly or monthly) not just one big payment at year end. Take pictures of them working if possible. And pay them a reasonable wage for their age and the work they're doing - don't pay your 10-year-old $50/hour for stuffing envelopes!

Just a heads up for anyone considering this - make sure you understand the state requirements too! I implemented this strategy with my home-based marketing consulting business last year, paying my 16 and 14-year-old kids for legitimate work (social media management, data entry, client research). While the federal tax benefits worked exactly as described, I learned the hard way that some states have additional requirements for employing minors, even in family businesses. In my state, I needed to get work permits for both kids and follow specific hour restrictions during school months. Also, don't forget about workers' compensation insurance requirements - some states require it even for family employees in certain business types. I had to adjust my business insurance policy to cover them. The tax savings were definitely worth it (saved about $3,200 in taxes last year), but factor in these additional compliance costs when you're calculating the benefit. Still came out way ahead, but wished I'd known about the extra requirements upfront!