Hiring Your Kids: Wages, Roth IRA Funding, and Audit Risk (2026)

A Phoenix-based dentist running a solo practice as a Schedule C filer hires his 15-year-old daughter to handle patient intake filing, sterilize instruments, and manage social media posts for the practice. He pays her $14,000 for 2026 — roughly $17/hour for 16 hours a week during the summer and 8 hours a week during the school year. She owes zero federal income tax (under the $15,750 standard deduction), zero Social Security and Medicare tax (under-18 child of a sole proprietor per IRC § 3121(b)(3)(A)), and she contributes $7,000 of those wages to a custodial Roth IRA. He deducts the full $14,000 as a business expense.

The family tax savings: at his 32% marginal bracket plus 2.9% Medicare tax (he's above the $181,800 Social Security wage base), the $14,000 deduction saves him $4,886 in federal taxes. His daughter pays $0. The $7,000 Roth contribution, invested at 8% average annual return, grows to roughly $150,000 by age 65 — completely tax-free. That's a multi-generational wealth transfer disguised as a summer job.

But the IRS has seen this playbook on every small-business audit for two decades. Here's how to do it right — and the specific traps that cost families the deduction.

The tax mechanics: why hiring your kids works

Three IRC provisions make family employment one of the most efficient income-shifting strategies available to sole proprietors:

• Business deduction (IRC § 162): wages paid to your child are deductible as ordinary and necessary business expenses — same as wages paid to any other employee. This reduces your taxable income dollar-for-dollar.
• FICA exemption (IRC § 3121(b)(3)(A)): wages paid by a sole proprietor (or a partnership where each partner is a parent) to a child under 18 are exempt from Social Security and Medicare taxes. Neither the employer nor the employee pays FICA. This is a 15.3% savings on the first $181,800 of combined wages (12.4% Social Security + 2.9% Medicare).
• FUTA exemption (IRC § 3306(c)(5)): wages paid to a child under 21 are exempt from the Federal Unemployment Tax (FUTA), saving another 0.6% on the first $7,000 of wages.

The net effect for a Schedule C filer in the 24% bracket paying a child under 18 the full $15,750 (standard deduction amount): the parent deducts $15,750, saving $3,780 in income tax plus avoiding $2,224 in SECA (15.3% × 92.35% × $15,750). The child owes $0 in income tax and $0 in payroll tax. Total family savings: roughly $6,004 — every year.

Entity choice matters: sole prop vs S-corp vs partnership

The FICA exemption is the single largest benefit of hiring your kids, and it only applies to specific entity types. This is where most online guides get sloppy.

The part most people miss: if you're running an S-corp — even a single-owner S-corp — the corporation is the employer, not you personally. The FICA exemption requires the parent to be the employer. An S-corp is a separate legal entity. This is settled law (see Robucci v. Commissioner, and IRS Publication 15 Circular E). The S-corp can still hire your child and deduct the wages, but it must withhold Social Security and Medicare taxes like any other employee.

The workaround some practitioners suggest: having the S-corp pay a management fee to a sole-prop management company owned by the parent, which then employs the child. The IRS has challenged this structure when the sole prop exists solely to route wages to family members. If you go this route, the management company must have genuine economic substance beyond employing your children.

How much to pay: the reasonable wage guardrail

The IRS applies a simple test: would you pay a non-related employee the same rate for the same work? If not, the excess is reclassified — you lose the deduction and potentially face penalties.

Reasonable wage benchmarks for common tasks:

The sweet spot for most families: $10,000 – $15,750 per year. Below $15,750 keeps the child entirely within the standard deduction (zero income tax). Above that, the child starts paying 10% on the excess. Both amounts still generate Roth IRA contribution room.

The Roth IRA play: 50 years of tax-free compounding

This is where hiring your kids goes from "nice deduction" to "generational wealth lever." A child with earned income can contribute to a Roth IRA — up to $7,500 in 2026 or their total earned income, whichever is less.

For a child under 18, this is a custodial Roth IRA held by the parent as custodian until the child reaches the age of majority (18 or 21, depending on the state). The child owns the account. The parent manages it.

Worked example: $7,500/year Roth contribution from age 14 to 18

That's $37,500 in after-tax dollars (which were effectively tax-free to the child) turning into $1.2 million of tax-free retirement money. No other legal structure gives a 14-year-old access to this kind of compounding runway.

Important: the parent or anyone else can give the child money to fund the Roth contribution — the child doesn't have to use the actual paycheck. The only requirement is that the child has earned income equal to or greater than the Roth contribution. So a child earning $14,000 could spend their paycheck on normal teenager things while a parent separately funds $7,500 into the custodial Roth.

Audit risk: what the IRS actually looks for

Hiring your kids is legal and well-established. But it's also on the IRS's radar specifically because it's popular. The Tax Court has ruled on family employment cases dozens of times, and the pattern of what survives audit is clear.

Five things the IRS checks on exam

1. Was the work real and business-related? Cleaning your house is not a business expense. Cleaning the business office is. Mowing your lawn is not deductible. Mowing the lawn of a rental property you own as a business — yes. The distinction is whether the task would exist and require payment if the child didn't do it.
2. Was the wage reasonable for the work performed? Paying a 13-year-old $40/hour to shred documents will not survive scrutiny. The IRS compares to prevailing market rates for the same work in your area. Use local job-listing rates as your benchmark.
3. Did you keep formal payroll records? You need: a completed W-4 on file, time sheets or a time-tracking log, pay stubs or a pay register, a W-2 issued at year-end, and payment by check or direct deposit to the child's own bank account. Cash payments with no paper trail are audit kryptonite.
4. Was the child actually capable of doing the work? An 8-year-old "managing inventory" in your e-commerce business will raise questions. A 16-year-old doing the same work is plausible. Match the job to the child's actual capabilities.
5. Did you file correctly? Report the wages on your Schedule C (or partnership return) as a deduction. Issue a W-2. If applicable, file Schedule H. Errors in filing are easy flags.

Documentation checklist

• Written job description — what the child does, how many hours, what rate
• Signed employment agreement (even if informal — one page is fine)
• Time logs — weekly entries showing hours worked and tasks performed
• Pay stubs or payment records — bank statements showing regular transfers
• W-4 on file (even if no withholding is required)
• W-2 issued by January 31 of the following year
• Photos or work samples (especially for social media, content creation, or design work) — timestamped evidence the child actually produced something

The standard the IRS applies: if you would have hired someone else to do this work and paid them a similar rate, the deduction stands. If the "job" only exists because you have a child you want to shift income to, it fails. The burden of proof is always on the taxpayer.

Child labor law compliance

Tax law and labor law are separate regimes. Even if the IRS allows the deduction, state labor authorities can still fine you for violations.

• Federal (FLSA): children under 14 generally cannot be employed in non-agricultural businesses, but the FLSA explicitly exempts children employed by their parents in non-mining, non-manufacturing, non-hazardous occupations. This is the exemption most family businesses rely on.
• State laws: many states have stricter rules — hour limits during school weeks, prohibited occupations, work permit requirements for minors. California, New York, and Massachusetts are particularly strict. Check your state's department of labor website.
• Minimum wage: if your state's minimum wage is $15/hr, you must pay at least that — even to your child. Federal minimum wage is $7.25, but most states and many cities exceed it.

Interaction with the QBI deduction (§199A)

Child wages are a business deduction, which reduces your Qualified Business Income. At the 20% QBI deduction rate, every $1,000 you pay your child reduces your QBI deduction by $200.

Example: a sole proprietor with $200,000 of Schedule C income (before child wages) in the 24% bracket. She pays her child $15,000.

• Income tax savings from the $15,000 deduction: $3,600 (24%)
• SECA savings (child under 18, sole prop): $2,119 (15.3% × 92.35% × $15,000)
• Lost QBI deduction: $15,000 × 20% = $3,000 × 24% tax rate = $720 cost
• Net family savings: $4,999

The QBI reduction is real but modest. The income tax + SECA savings always exceed the QBI cost when the child's income stays within the standard deduction. For filers in a Specified Service Trade or Business (SSTB) above the §199A phase-out ($197,300 single / $394,600 MFJ in 2026), the QBI deduction is already gone — child wages save at the full marginal rate with no offset.

When hiring your kids doesn't make sense

• Your business is an S-corp and the FICA savings were the main draw. Without the FICA exemption, you're shifting income but paying 15.3% payroll tax on every dollar of the child's wages. The net savings shrinks to just the bracket arbitrage between your rate and the child's rate — and for wages under $15,750, the child's rate is 0%, so there's still a benefit, just smaller.
• Your child is too young to do credible work. A 6-year-old "modeling" for your business website is a stretch. If you can't defend the work as legitimate in a Tax Court memo, don't take the deduction.
• You can't maintain the paperwork. If you won't keep time logs, issue W-2s, and pay through a trackable method — don't start. An undocumented arrangement is worse than no arrangement because it creates the appearance of a sham.
• The child has significant other income. If your child already earns $20,000 from a part-time job, additional wages push them above the standard deduction into taxable territory. The strategy works best when your child has little or no other earned income.

Decision framework: should you hire your kids?

If you're a sole proprietor or single-member LLC with a child age 14–17 who can do real business work: this is one of the cleanest tax strategies in the code. Deductible wages, no FICA, no FUTA, and the child builds Roth IRA contribution room. Set up proper payroll, document everything, and pay a market rate.

If you're an S-corp owner: the strategy still works for income shifting, but the FICA exemption is gone. Run the numbers — the bracket arbitrage (your 24%+ rate vs. the child's 0%) still produces real savings, just not as dramatic.

If the Roth IRA angle is the primary goal: even modest wages of $5,000–$7,500 per year fund a full or near-full Roth contribution. Five years of $7,500 contributions starting at age 14 builds a $37,500 base that, untouched, reaches seven figures by retirement. The earlier you start, the more compounding does the work.

If audit risk keeps you up at night: the defense is documentation, not avoidance. Families who keep clean records, pay market rates, and assign real work survive audits. Families who pay their 10-year-old $15,000 to "help around the office" with no time logs and cash payments do not. The difference is paperwork, not legality.

Hiring your kids is one of the few strategies where the IRS rules explicitly support what you're doing — the exemptions are written into the code, not loopholes exploited around it. The risk isn't in the strategy. It's in the execution.