Last updated: February 2026
The idea of an IRS audit makes most business owners nervous. When you add family employment into the mix, that anxiety goes up another level. Will the IRS believe the work is real? Will they question the wages? Will they disallow the deduction?
Here's the reality: the IRS is completely fine with business owners hiring their children. It's written into the tax code. What they're not fine with is fabricated employment, inflated wages, and missing documentation. If your arrangement is real and well-documented, an audit is nothing more than a paperwork exercise.
What Triggers an Audit?
The IRS doesn't randomly audit every business owner who pays their child. Certain factors can increase the likelihood of scrutiny.
- Unusually high wages for a child's age. Paying your 8-year-old $30,000 a year to "help around the office" is going to raise questions. Paying them $6,000 for documented part-time administrative work is perfectly reasonable. See: Reasonable Wage Guide for 2026.
- Large or sudden deductions. If your business income is $80,000 and you suddenly deduct $48,000 in wages paid to your three children, the proportion may trigger a closer look.
- Inconsistent reporting. If you claim the wages on your business return but your child doesn't file their own return reporting the income, the mismatch can generate an automated notice.
- Missing W-2s or payroll records. Without these documents, the IRS has no way to verify the employment exists. Read: Why You Need to Run Proper Payroll.
What the IRS Looks For
If the IRS does examine your child's employment, they're checking four main things.
Was real work performed? They want to see that your child actually did something for the business. Time records, task descriptions, and any work product serve as evidence. A log showing "Dylan organized 45 tenant files and shredded outdated documents, 2 hours" is exactly the kind of detail that works. For task ideas by age, read: 50+ Legitimate Tasks You Can Pay Your Kids.
Is the compensation reasonable? The wages should align with what you'd pay a non-family member for the same work. The IRS may look at local wage data or comparable rates for similar tasks.
Are proper records maintained? Time logs, payment records, job descriptions, and W-2s. For the full checklist: What Records to Keep for the IRS and Kids Payroll Checklist: W-4, I-9, and Everything You Need to File.
Is the arrangement structured correctly? This includes making sure the right entity is paying the child (important for S Corp owners using a Family Management Company), that the child isn't being paid for personal tasks, and that the employment relationship is treated like any other hiring arrangement.
What Happens If You Fail the Audit?
If the IRS determines the employment wasn't legitimate, the consequences typically include:
- Disallowance of the wage deduction, meaning you owe the taxes you would have paid without the deduction plus interest
- Back payroll taxes if FICA exemptions were incorrectly claimed
- Accuracy-related penalties of 20% in some cases
Most audit outcomes for family employment come down to documentation. Business owners who kept good records rarely have issues. Those who treated it casually -- no time logs, cash payments, no written agreements -- are the ones who lose.
How to Audit-Proof Your Records
The best defense is straightforward: run your child's employment like you would any other employee's.
Maintain consistent time records. Log every work session with the date, hours, and specific tasks performed. "Helped with business" isn't enough detail. "Organized filing cabinet, scanned 30 receipts into accounting system" is.
Pay through your business bank account. Every payment should show up as a traceable transaction from your business to your child. See: How to Open a Bank Account for Your Child.
Keep a current job description. Update it annually as your child's responsibilities grow. A six-year-old shredding documents has a different job description than an eleven-year-old handling administrative tasks.
File properly. Issue a W-2, report the income on your child's tax return, and make sure your business return correctly reflects the wage deduction.
After six years of paying my daughter Dylan, the documentation habit becomes second nature. We track her hours as she works, note the tasks she completes, and everything is organized before tax season. If the IRS ever comes calling, we hand over the records and move on.
Frequently Asked Questions
How far back can the IRS audit my child's payroll?
The IRS generally has three years from the filing date to audit a return. If they suspect substantial underreporting (more than 25% of gross income), they can go back six years. In cases of fraud, there's no time limit.
Should I have my child sign anything?
Having a simple written employment agreement is helpful. For younger children, you sign it as both the employer and the parent. For teenagers, their signature on time records adds another layer of verification.
Does hiring my child increase my audit risk?
Not significantly, as long as the deduction is reasonable relative to your business income and the wages are properly documented. The IRS audits a very small percentage of returns overall.
Can Kids Payroll help if I get audited?
Kids Payroll generates organized records of hours worked, tasks completed, and payment history. Having this information in one place makes responding to any IRS inquiry straightforward. You can export a complete documentation package at any time.
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.