Hiring Family Members: Income Splitting, Kiddie Tax, and the Rules for Employing Your Children

By Yarik Yarosh, CPA ·September 5, 2026 ·6 min read

Written by Yarik Yarosh, CPA (US & Canada) September 5, 2026 · FL CPA license AC61704 · CPA Ontario

Hiring your children and spouse in the family business is one of the most straightforward and effective tax planning strategies in the code, but it comes with specific rules that must be followed precisely to avoid IRS challenge. The headline benefit: a child under 18 employed by a parent’s sole proprietorship (or a partnership where both partners are the child’s parents) is completely exempt from FICA taxes under IRC 3121(b)(3)(A). Combined with the child’s standard deduction ($15,000 for 2025), the first $15,000 of wages paid to the child is free of both income tax and FICA, shifting income from the parent’s 35%+ bracket to the child’s 0% bracket. The kiddie tax under IRC 1(g) does not apply to earned income (wages from employment), only to unearned income (investment income, interest, dividends), so legitimate wages to children are taxed at the child’s own rate regardless of the parents’ tax bracket.

✓Key takeaway

Family employment tax benefits:

Family Member	Key Tax Benefit	Authority
Child under 18 (sole proprietorship)	Exempt from FICA (Social Security + Medicare)	IRC 3121(b)(3)(A)
Child under 21 (sole proprietorship)	Exempt from FUTA (federal unemployment tax)	IRC 3306(c)(5)
Child under 18 (S-Corp or C-Corp)	NOT exempt from FICA (exemption only applies to sole proprietors and qualifying partnerships)	IRC 3121(b)(3)(A)
Spouse	Can participate in employer’s retirement plan; medical expense reimbursement plan	IRC 105, 401(a)
Parent employed by child	Exempt from FUTA	IRC 3306(c)(5)

Income shifting math (child under 18, sole proprietorship):

Item	Parent’s Bracket	Child’s Bracket
Federal income tax rate	35%+	0% (up to $15,000 standard deduction)
FICA tax (self-employment)	15.3%	0% (exempt)
Combined rate on $15,000	$7,545+	$0

Kiddie tax rules (IRC 1(g)):

Type of Income	Subject to Kiddie Tax?	Rate
Earned income (wages from employment)	NO	Child’s own rate
Unearned income over $2,700 (2025)	YES (if under 19, or full-time student under 24)	Parents’ marginal rate
Unearned income, first $1,350	NO	Tax-free
Unearned income, $1,350-$2,700	NO	Child’s rate

How much can a family save by employing children?

Hypothetical example

Round numbers. A married couple operates a consulting business as a sole proprietorship. Combined income: $300,000 (35% bracket). They have two children, ages 14 and 16, who help with legitimate business tasks.

Employment structure:

Child	Age	Tasks	Hours/Week	Hourly Rate	Annual Wages
Child A	14	Data entry, filing, cleaning office, social media	10	$15	$7,800
Child B	16	Customer service responses, website updates, inventory	12	$17	$10,608
Total					$18,408

Tax savings from hiring children (sole proprietorship):

Item	Amount
Wages paid to children	$18,408
Parent’s income tax savings (35% x $18,408)	$6,443
Parent’s SE tax savings (15.3% x $18,408)	$2,816
Children’s income tax	$0 (each child’s wages are under the $15,000 standard deduction)
Children’s FICA	$0 (exempt, under 18, sole proprietorship)
Net family tax savings	$9,259/year

Over 4 years (until each child turns 18):

Year	Wages	Tax Savings
Year 1 (both working)	$18,408	$9,259
Year 2 (both working, modest raise)	$19,500	$9,808
Year 3 (Child A working, Child B turns 18)	$9,360	$4,708
Year 4 (Child A working)	$10,400	$5,231
4-year total	$57,668	$29,006

What the children can do with their earnings (tax-free compounding):

Action	Amount	Tax Impact
Contribute to Roth IRA (up to earned income, max $7,000)	$7,000/year per child	Tax-free growth forever
Save for college (529 plan funded by parent from saved taxes)	Parent’s tax savings	Tax-free growth for education
Open a brokerage account	Remainder	Kiddie tax applies to unearned income over $2,700

Roth IRA impact (Child A, age 14, contributes $7,000/year for 4 years):

Item	Amount
Total contributions	$28,000
Value at age 65 (8% average return, 51 years of growth)	~$1,400,000
Tax on withdrawal	$0 (Roth)

The S-Corp trap: If the business is an S-Corp instead of a sole proprietorship:

Structure	FICA on Child’s Wages	Income Tax Savings
Sole proprietorship	$0 (exempt)	Full (income shifting works)
S-Corp	$1,408 (7.65% employee + 7.65% employer on $9,204 per child)	Full (income shifting works)

The S-Corp loses the FICA exemption because IRC 3121(b)(3)(A) exempts only services performed for a parent’s sole proprietorship (or qualifying partnership), not services for a corporation. The income tax shifting benefit still works with an S-Corp, but the FICA savings are lost.

Workaround for S-Corp owners: The S-Corp owner can create a sole proprietorship management company that provides management services to the S-Corp. The sole proprietorship hires the children. This preserves the FICA exemption, but the structure must have economic substance and the management company must be a legitimate business.

Spouse employment benefits:

Benefit	How It Works
Retirement plan participation	Spouse employed by the business can participate in the business’s 401(k), SEP, or defined benefit plan
Section 105 HRA	Spouse covered by an HRA can reimburse family medical expenses tax-free
Social Security credits	Spouse builds their own Social Security earnings record
Earned income for IRA	Spouse has earned income to contribute to their own IRA/Roth IRA

Medical expense reimbursement through spouse employment: If the business has no other employees (or covers all employees equally), the owner can establish a Section 105 plan for the employed spouse, and the spouse’s plan covers the entire family (including the owner):

Without Plan	With Plan
Medical expenses: personal (not deductible unless >7.5% AGI)	Medical expenses: fully deductible as business expense
Family premium: $20,000/year (no deduction)	Family premium: $20,000/year (fully deductible)
Tax savings at 35% bracket	$0

Documentation requirements:

Requirement	What to Keep
Job description	Written description of duties appropriate for the child’s age
Time records	Hours worked (timesheet signed by child)
Reasonable pay	Comparable to what you would pay a non-family worker for the same tasks
Actual work performed	The child must actually perform the work
W-4 and payroll records	File W-4, issue W-2, maintain payroll records
State labor law compliance	Follow state child labor laws (hours, types of work, permits)
No sham payments	Cannot pay child $50/hour for sweeping if market rate is $12

Illustrative numbers only, not a real client and not advice for your facts.

Related guides:

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Cite this page

Yarik Yarosh, CPA. "Hiring Family Members: Income Splitting, Kiddie Tax, and the Rules for Employing Your Children." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-family-employment-kiddie-tax-income-splitting

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.