Last updated: February 2026
I was talking to a friend recently and mentioned that we've been paying our daughter Dylan (now 11) as an employee in our business since she was 5 years old.
Her jaw dropped.
She had no idea this was even legal. And honestly, that's the reaction I get almost every time I bring it up. Most business-owner parents don't know this is an option, and the ones who do are often too nervous about the IRS to actually set it up.
So let me break down exactly what we do, how it works, and why it's one of the smartest financial moves we've made as a family.
The Big Picture: Why This Works
Since payroll is a tax-deductible business expense, paying your child reduces your taxable income. And as long as your child's earnings stay under the standard deduction (which is $14,600 in 2025 and $16,100 in 2026), they pay zero federal income tax on that money.
Read that again. You move money from your business (where it would've been taxed at your rate) to your child (where it's taxed at zero), and the whole thing is a legitimate, IRS-recognized business deduction.
If you're a sole proprietor or a single-member LLC, it gets even better: wages you pay your child under 18 are also exempt from Social Security and Medicare taxes (FICA). No FICA for you, no FICA for them. Wages to your child under 21 are exempt from federal unemployment tax (FUTA) too.
We're not talking about a loophole. This is written directly into the tax code. The IRS expects business owners to take advantage of it, as long as you do it the right way.
Here's how.
Step 1: Figure Out What Your Kid Can Actually Do
This is where most people get stuck. They think their kid needs to be old enough to sit at a desk and answer phones. Not even close.
When Dylan was 5, she was filing papers, shredding documents, applying stamps to envelopes, opening mail, and helping with basic admin tasks. Was she running our business? Obviously not. But she was doing real work that we would have otherwise done ourselves or paid someone else to do. That's the standard.
Now at 11, she does property due diligence, basic customer support, transcribes call recordings, and handles more technical online tasks. She even helped build and test our Kids Payroll app.
You'd be surprised what kids are capable of when you give them real responsibility instead of busywork. Check out our 50+ legitimate tasks you can pay your kids for ideas by age group.
The key here is that the work has to be real. The IRS isn't going to question whether a 7-year-old can shred documents. But they will question it if you're paying your toddler $50 an hour to "consult." Keep it honest, keep it age-appropriate, and document what they do.
Step 2: Set a Reasonable Hourly Rate
The IRS requires that compensation be "reasonable" for the work performed. There's no hard rule on what "reasonable" means, but we keep it simple: we pay Dylan minimum wage in our state.
Could we justify a higher rate for some of the tasks she does now at 11? Probably. But minimum wage keeps things conservative and removes any question of whether we're inflating her pay to maximize our deduction. We'd rather stay clearly in bounds than push it.
If you're in a state with a higher minimum wage, that actually works in your favor. Your child earns more, your deduction is larger, and the rate is easily defensible because it's literally the legal minimum.
Step 3: Open a Bank Account for Your Child
If your child is under 13, you'll need to open a joint account, since most banks require a parent on the account. If they're 13 or older, some banks allow custodial accounts where the child has more ownership. See our guide to opening a bank account for your child.
Either way, the important thing is that payroll goes directly into this account via direct deposit or a check. Don't pay your kids in cash and call it a day. You want a clear paper trail showing money moving from your business account to their personal account.
This also creates a great teaching moment. Dylan checks her bank balance, sees her money grow, and understands the direct connection between work and income. That's not something you can teach from a textbook.
Step 4: Open a Custodial Roth IRA
This is where the strategy goes from "good tax move" to "generational wealth builder."
Once your child has earned income, they qualify for a Roth IRA. We use Vanguard, but Fidelity and Schwab work too. You deposit their payroll earnings into the Roth IRA, up to the annual contribution limit ($7,000 in 2025 and 2026, or their total earned income, whichever is less).
Here's what makes this powerful: that money grows tax-free for the rest of their life. And when they withdraw it in retirement, it comes out tax-free too.
A 5-year-old with a Roth IRA has a 60-year head start on compound growth. Run the numbers on that and it gets ridiculous fast. Even modest contributions now can grow into serious money by the time your child retires.
And since their income is under the standard deduction, they didn't pay income tax on the money going in either. Tax-free in, tax-free growth, tax-free out.
Step 5: Track Their Hours and Pay Them on a Regular Schedule
You need to track actual hours worked and pay on a consistent schedule. We pay monthly, but you could do biweekly or whatever fits your family.
We use the Kids Payroll app for this. Dylan and I actually built it together when spreadsheets stopped cutting it. It tracks tasks, logs hours, and keeps all the documentation in one place so you're not scrambling at tax time.
Whatever system you use, make sure you're keeping records of what your child did, when they did it, and how much they were paid. If the IRS ever asks, you want to be able to hand over clean records, not a shoebox of sticky notes. See our complete payroll checklist for everything you need.
Step 6: Recalculate Your Health Insurance Premium
This one flies under the radar, but it's a big deal.
Paying your children is a deductible business expense, which reduces your adjusted gross income (AGI) and your Modified Adjusted Gross Income (MAGI). If you buy health insurance through the ACA marketplace, your premium subsidy is calculated based on MAGI.
Lower MAGI = larger subsidy = lower monthly premium.
If you saw my post about how we pay $178 a month for health insurance for our whole family, this is one of the strategies that helps keep that number low. It all connects: the payroll deduction lowers your income on paper, which cascades into real savings on insurance, and potentially into lower self-employment tax and qualification for other tax benefits.
The Part I Didn't Expect
The financial benefits are real and they add up fast. But honestly, the part I didn't expect is how much Dylan has grown from this arrangement.
She understands money in a way that most adults don't. She knows what it means to earn something. She can talk about saving, investing, and compound interest, not because we lectured her about it, but because she's living it.
When she deposits her paycheck and sees her Roth IRA balance growing, that's not abstract. That's hers. She earned it.
That's been worth more than any tax deduction.
A Few Important Things to Keep in Mind
Business structure matters. The FICA and FUTA exemptions only apply if you're a sole proprietor or a qualifying partnership (where both partners are the child's parents). If your business is an S-Corp or C-Corp, the corporation is the employer, not you, and those payroll tax exemptions don't apply. The income tax deduction still works, but you'll owe payroll taxes on both sides. Consider a Family Management Company as a workaround.
State laws vary. Every state has different rules around what ages children can work, how many hours they can work, and whether you need a work permit, even in a family business. Check our state-by-state guide to see exactly what applies where you live.
Keep it reasonable and documented. Pay a fair rate for real work. Track hours. Keep records. The IRS doesn't have a problem with this strategy when it's done legitimately. They have a problem when people fabricate work or pay unreasonable wages.
This is not legal or tax advice. I'm sharing what works for our family. Talk to your CPA or tax advisor about your specific situation before implementing anything.
Ready to Set This Up for Your Family?
We built the Kids Payroll app because we needed it ourselves — and now thousands of other business-owner families use it too. It handles task tracking, hour logging, and documentation so you stay compliant without the spreadsheet headache.
Use our Tax Savings Calculator to see exactly how much your family could save.
Disclaimer: This article is for educational purposes only and does not constitute tax or legal advice. Consult a qualified CPA or tax professional for guidance specific to your situation.