Putting Your Child on Payroll: Tax Benefits and Planning Considerations for Business Owners

By Michael Ruger, CFP®
Partner and Chief Investment Officer at Greenbush Financial Group

For business owners, employing your child in the family business can be both financially and personally rewarding. Not only does it teach children about responsibility and work ethic, but it can also open up meaningful tax and retirement planning opportunities. However, this strategy comes with important rules and limitations that need to be carefully understood before implementation.

In this article, we’ll cover:

• Why parents consider putting their children on payroll

• The tax benefits of shifting income

• How retirement plan contributions can supercharge long-term wealth for kids

• Using W-2 wages to fund Roth IRAs

• Key limitations and compliance concerns to keep in mind

Shifting Income: The Tax Advantage

One of the primary motivations for hiring your child is income shifting—moving taxable income from a higher-bracket parent to a lower-bracket child.

For example, instead of paying yourself additional compensation taxed at 37%, you could pay your child for legitimate work at their much lower (or even 0%) tax bracket. The wages are deductible for the business, and the child may owe little to no federal income tax, depending on their total earnings.

This strategy can effectively lower the family’s overall tax bill while compensating your child fairly for real work.

Retirement Plan Contributions for Your Child

If your child is legitimately on payroll, they may also become eligible for participation in the company’s retirement plan. With the right plan design, this could allow:

• 401(k) deferrals (including Roth contributions) up to $23,500 per year in 2025

• Employer contributions in addition to employee deferrals, depending on plan rules.

Imagine the power of decades of tax-free Roth 401(k) growth starting in your child’s teenage years. Even modest contributions today could compound into significant wealth by retirement.

Funding a Roth IRA

Even if your child doesn’t earn enough to max out a 401(k) or work enough hour to become eligible for the company’s 401(k) plan, any earned income reported on a W-2 makes them eligible to contribute to a Roth IRA.

• The 2025 contribution limit is $7,000 for individuals under age 50.

• Contributions must not exceed the child’s earned income for the year.

This is one of the most effective long-term wealth accumulation strategies available for young workers, given the decades of tax-free growth that a Roth IRA can provide.

Practical Limitations and Compliance Concerns

While the benefits are clear, there are serious rules and restrictions that business owners must respect:

• Reasonable work and pay: The job duties and pay must be appropriate for the child’s age and abilities. A 6-year-old making $30,000 a year for “marketing or consulting” is not likely to pass IRS scrutiny.

• Labor laws: States impose restrictions on how much and what type of work minors can do. These vary by state, and compliance is essential.

• Payroll compliance: Children on payroll must be treated like any other employee—filed on W-2s, subject to FICA taxes (unless an exception applies), and paid at reasonable market rates.

• Retirement plan eligibility: Not all plans allow immediate participation. Some require minimum service or age thresholds. Plan design must be reviewed before assuming your child can make contributions.

• Audit risk: Employing family members can attract IRS attention. Documentation of actual work performed (e.g., timesheets, job descriptions, projects completed) is important.

Other Considerations

While putting children on payroll can save taxes and accelerate wealth-building, it’s not a one-size-fits-all strategy. Business owners must weigh:

• The cost of payroll taxes on the child’s wages

• Retirement plan contribution obligations for other employees if the child becomes eligible

• Administrative requirements and state-specific child labor rules

• The optics of compensation relative to duties performed

Key Takeaways

• Hiring your child can shift income into a lower tax bracket and reduce the family’s overall tax bill.

• Payroll wages open the door to retirement savings strategies like Roth 401(k) contributions (if the plan allows) and Roth IRAs (up to $7,000 per year).

• Plan design, labor laws, and IRS scrutiny mean you must be cautious, document carefully, and ensure the arrangement is reasonable.

• This strategy can be powerful for both tax savings today and long-term wealth accumulation for your child—but it must be implemented correctly.

Before putting your child on payroll, consult with both your tax advisor and your retirement plan administrator. Done right, this can be a smart family wealth-building strategy. Done wrong, it can create compliance headaches.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions (FAQs)

Why would a business owner put their child on payroll?
Hiring your child allows you to shift income from a higher tax bracket to a lower one, reducing the family’s overall tax liability. It also helps children learn valuable work and financial skills while legitimately earning income.

How does hiring a child create tax benefits?
Wages paid to a child for real work are deductible business expenses, lowering the company’s taxable income. Meanwhile, the child may owe little to no federal income tax if their earnings stay below standard deduction thresholds.

Can my child contribute to a retirement plan if they work for my business?
Yes. If they meet eligibility requirements, children can make 401(k) contributions—including Roth deferrals—through your company’s retirement plan. Even small contributions in their early years can compound significantly over time.

Can my child open a Roth IRA with earned income?
Absolutely. As long as your child earns income reported on a W-2, they can contribute up to $7,000 per year (2025 limit) to a Roth IRA, not exceeding their total earned income. Roth IRAs are especially powerful for young workers due to decades of tax-free growth.

What are the key IRS and labor law rules when employing your child?
The work must be age-appropriate, pay must be reasonable for the duties performed, and proper payroll procedures must be followed. Employers must also comply with state child labor laws and maintain documentation of actual work performed.

Are there any risks or downsides to hiring your child?
Yes. Improper pay, lack of documentation, or failure to follow labor laws can trigger IRS scrutiny. Additionally, adding your child to the company’s payroll may create additional administrative costs or affect retirement plan participation rules.

What should business owners do before putting their child on payroll?
Consult with your tax advisor and retirement plan administrator to ensure the arrangement complies with IRS and labor regulations. Proper planning helps you maximize tax benefits while avoiding compliance issues.