Every year, this comes up. Someone hears it from a friend, a podcast, or some guy online who claims you can “pay your kids” and save taxes. By the time it gets repeated a few times, it starts sounding like something every business owner should already be doing
The rationale is what makes it appealing. Business owners are usually in higher tax brackets, while their children—especially minors—are often in little to no tax bracket at all. The idea is to shift income: deduct it at the parent’s higher tax rate and have it taxed at the child’s lower rate. This is known as tax arbitrage, and in general, it is a sound strategy.
But there is a question that needs to be answered first: what work will the child actually perform?
Because that’s the part that matters. Paying your children through the business is not the issue. The problem is paying them when there’s no real work, no defined role, no documentation, or paying them far more than the work is actually worth. At that point, it stops being tax planning and starts looking like an attempt to manufacture deductions that do not exist.
The IRS requires wages to be tied to actual services performed. If there is no legitimate work, there is no business purpose, and if there is no business purpose, then the payroll is illegitimate. That is not a sophisticated strategy—it’s fraudulent.
Another thing to consider is that even when the wages are legitimate, the tax benefit is often smaller than people expect. Sometimes paying your children means taking income that was not subject to FICA taxes and converting it into income that is. When that happens, both the employee and employer are paying 7.65%, and a meaningful portion of the income tax savings may disappear.
If your children are genuinely working in the business, pay them. If they are not actually working, then don’t. Instead, look to legitimately reduce your tax burden and engage in tax arbitrage by using tools that were designed for that purpose. Solo 401(k)s, defined benefit plans, IRAs, and HSAs exist because Congress intentionally built those incentives into the tax code to encourage certain types of savings and investment behavior. Stop playing games and use those tools.
