--- title: "FICA & FUTA Exemptions: Sole Prop to S Corp Mid-Year | Kids Payroll" description: "Learn exactly when FICA and FUTA exemptions end during a mid-year sole prop to S corp conversion and how a Family Management Company keeps them alive." lang: en json-ld: | [ { "@context": "https://schema.org", "@type": "BlogPosting", "headline": "FICA & FUTA Exemptions: Sole Prop to S Corp Mid-Year", "description": "Learn exactly when FICA and FUTA exemptions end during a mid-year sole prop to S corp conversion and how a Family Management Company keeps them alive.", "url": "https://kidspayroll.com/blog/what-happens-to-fica-and-futa-exemptions-when-a-sole-proprietorship-converts-to-an-s-corp-mid-year/", "image": "https://images.unsplash.com/photo-1516728043722-b394cb2f689e?crop=entropy&cs=tinysrgb&fit=max&fm=jpg&ixid=M3w5MjA2ODF8MHwxfHNlYXJjaHwyM3x8YnVzaW5lc3MlMjBwYXBlcndvcmslMjBjYWxlbmRhciUyMGRlc2slMjBjb252ZXJzaW9ufGVufDB8MHx8fDE3ODMwMDkwMTR8MA&ixlib=rb-4.1.0&q=80&w=1080", "author": { "@type": "Person", "name": "Jennifer", "url": "https://kidspayroll.com/about/" }, "publisher": { "@type": "Organization", "name": "Kids Payroll", "url": "https://kidspayroll.com", "logo": { "@type": "ImageObject", "url": "https://kidspayroll.com/favicon.png" } }, "datePublished": "2026-07-02", "dateModified": "2026-07-02", "mainEntityOfPage": { "@type": "WebPage", "@id": "https://kidspayroll.com/blog/what-happens-to-fica-and-futa-exemptions-when-a-sole-proprietorship-converts-to-an-s-corp-mid-year/" }, "isPartOf": { "@type": "Blog", "@id": "https://kidspayroll.com/blog/", "name": "Kids Payroll Blog" } }, { "@context": "https://schema.org", "@type": "BreadcrumbList", "itemListElement": [ { "@type": "ListItem", "position": 1, "name": "Home", "item": "https://kidspayroll.com" }, { "@type": "ListItem", "position": 2, "name": "Blog", "item": "https://kidspayroll.com/blog/" }, { "@type": "ListItem", "position": 3, "name": "What Happens to FICA and FUTA Exemptions When My Sole Proprietorship Converts to an S Corp Mid-Year", "item": "https://kidspayroll.com/blog/what-happens-to-fica-and-futa-exemptions-when-a-sole-proprietorship-converts-to-an-s-corp-mid-year/" } ] }, { "@context": "https://schema.org", "@type": "BreadcrumbList", "itemListElement": [ { "@type": "ListItem", "position": 1, "name": "Home", "item": "https://kidspayroll.com" }, { "@type": "ListItem", "position": 2, "name": "Blog", "item": "https://kidspayroll.com/blog" }, { "@type": "ListItem", "position": 3, "name": "What Happens to FICA and FUTA Exemptions..." } ] } ] --- [Kids Payroll ](/) FeaturesHow It WorksBenefits[State Laws](/state-labor-laws/)[Free Guide](/guide/)[Tax Calculator](/tax-calculator/)[About](/about/)[Blog](/blog/)[FAQ](/faq/)[Download App](https://apps.apple.com/us/app/kids-payroll-pay-your-kids/id6755955657) 1. [Home ](/) 2. [Blog](/blog/) 3. What Happens to FICA and FUTA Exemptions... Family Business # What Happens to FICA and FUTA Exemptions When My Sole Proprietorship Converts to an S Corp Mid-Year 9 min read Converting your sole proprietorship to an S corp mid-year is one of the most consequential payroll decisions a parent-employer can make. The timing ripples straight into your kids' paychecks, and not in the direction most people expect. > **TL;DR:** The FICA exemption under IRC §3121(b)(3)(A) and the FUTA exemption under IRC §3306(c)(5) apply only while wages are paid by a sole proprietorship, single-member LLC, or parents-only partnership. The moment your entity converts to an S corp, both exemptions end for wages paid by the new entity, even if the conversion happens on July 1. Wages paid before conversion stay exempt. Wages paid after do not. _Written by the Kids Payroll team, grounded in IRC §3121(b)(3)(A) and current IRS guidance on legitimately employing your children in a family business._ GUIDE #### Want the full 7-step playbook as a PDF? Get the same guide my readers use to set this up correctly the first time. Sent to your inbox in 60 seconds. Get the Guide → * * * ## When Do the FICA and FUTA Exemptions Actually End? The exemptions end on the effective date of conversion. Full stop. The IRS does not prorate these exemptions by month or by quarter. What matters is the employer entity type at the time each paycheck is issued. If your S corp election is effective July 1 and you pay your 15-year-old on July 15, the company issuing that paycheck is an S corp. That means Social Security tax (6.2%), Medicare tax (1.45%), and FUTA apply to that wage, just as they would for any unrelated employee. Wages you paid in January through June, while still a sole proprietorship? Those remain fully exempt from FICA and FUTA under the original rules. The mid-year split creates two payroll periods governed by two different sets of rules, and your W-2 at year-end has to reflect both. For a deeper look at how the exemption works during the sole prop phase, see our article on the [FICA exemption for minor children](https://kidspayroll.com/blog/fica-exemption-minor-children). * * * ## A Worked Example: The Mid-Year Math Let's make this concrete. Say you run a sole proprietorship that converts to an S corp effective July 1. You have a 14-year-old on payroll at $15 per hour, working 10 hours per week. **January 1 through June 30 (sole prop phase, 26 weeks):** - Hours worked: 26 weeks × 10 hours = 260 hours - Gross wages: 260 × $15 = $3,900 - FICA owed by employer: $0 (exemption applies under IRC §3121(b)(3)(A)) - FICA owed by employee: $0 - FUTA owed: $0 **July 1 through December 31 (S corp phase, 26 weeks):** - Hours worked: 260 hours - Gross wages: $3,900 - Employer FICA: $3,900 × 7.65% = $298.35 - Employee FICA: $3,900 × 7.65% = $298.35 - FUTA: $3,900 × 6% = $234 (before any state credit) **Full-year summary:** - Total wages to child: $7,800 - Total FICA cost to employer (full year): $298.35 - Total FICA withheld from child: $298.35 - Total additional cost vs. staying a sole prop all year: roughly $830 between employer and employee share That $830 might not sound dramatic, but it compounds across multiple kids and multiple years. And it is a permanent recurring cost, not a one-time hit, for every year you operate as an S corp. * * * ## Why Entity Type Is the Only Variable That Matters The FICA exemption under IRC §3121(b)(3)(A) is attached to the employer-employee relationship between a parent and their own child, specifically within the context of a sole proprietorship or a partnership where each partner is a parent of the child. The exemption has nothing to do with the child's age on its own. A 10-year-old working for their parent's S corp gets no exemption. A 17-year-old working for their parent's sole prop gets the full exemption. S corps are corporations under state law. When you elect S corp status, the IRS treats wages paid by that entity the same as wages paid by any other corporate employer. Congress wrote the exemption narrowly, and the IRS has consistently held that it does not extend beyond unincorporated entities owned by a parent. There is no workaround that keeps the exemption alive inside the S corp itself. This is the core tension covered in our comparison of [sole prop vs. S corp when paying your kids](https://kidspayroll.com/blog/sole-prop-vs-s-corp-paying-kids), and it is worth reading before you finalize any conversion timeline. * * * ## The Family Management Company: How to Preserve the Exemption After Conversion The most practical solution is one that has been used by tax professionals for years: the Family Management Company (FMC). Here is how it works. Instead of paying your children directly through the S corp, the S corp pays a management fee to a separate entity, typically a sole proprietorship or single-member LLC owned by one or both parents. That entity, the FMC, is the one that actually employs the children and issues their W-2s. Because the FMC is a sole proprietorship or parents-only entity, it qualifies for the IRC §3121(b)(3)(A) exemption. The children's wages paid through the FMC are exempt from FICA and FUTA, regardless of what the S corp is doing. **The structure must be real.** The FMC needs: 1. A separate bank account 2. A documented service agreement between the FMC and the S corp describing the management services provided 3. A reasonable management fee that reflects actual services 4. Payroll records showing the children's hours, tasks, and wages 5. W-2s issued by the FMC, not the S corp If the FMC is a shell with no actual operations, the IRS can collapse it and treat the wages as having been paid by the S corp all along. Courts scrutinize family arrangements closely, as illustrated by the Tax Court's approach in cases like _Eller v. Commissioner_, 77 T.C. 934 (1981), which emphasized that deductions for wages paid to family members require genuine work, reasonable wages, and real documentation. For a full walkthrough of setting up this structure, see our guide to [paying your kids tax-free through an S corp](https://kidspayroll.com/blog/s-corp-pay-kids-tax-free). * * * ## Practical Steps for a Mid-Year Conversion ### Key Takeaways at a Glance - Wages paid before the conversion date remain FICA and FUTA exempt. - Wages paid on or after the conversion date are fully subject to payroll taxes if paid by the S corp directly. - The split is tracked by the date each paycheck is issued, not prorated by year. - A Family Management Company, properly structured, restores the exemption for post-conversion wages. - You need two separate payroll setups if you use an FMC: one for the S corp's owner-employees and one for the FMC's child-employees. ### Step-by-step: What to do before the conversion date 1. **Confirm your conversion effective date.** This is the date on your IRS Form 2553 (S corp election) or the state entity conversion filing, whichever governs. Be precise. 2. **Run final exempt payroll under the sole prop.** Issue any wages through the sole prop before that date. Do not let the S corp issue its first paycheck and then retroactively try to reclassify it. 3. **Set up the FMC before the conversion, not after.** Open the FMC bank account, draft the service agreement, and establish payroll records for the FMC before the S corp starts operating. Retroactive setups invite scrutiny. 4. **Document the management fee.** The fee the S corp pays the FMC should be commercially reasonable. Benchmark it against what a third-party management firm would charge for the same services. 5. **Issue separate W-2s at year-end.** The child may receive one W-2 from the FMC covering the full year if the FMC employs them throughout. If the child received wages from the sole prop before it converted and then the FMC after, you may have two W-2s to reconcile. * * * ## What About the Child's Tax Situation? Here is the good news: converting to an S corp mid-year does not change the child's federal income tax picture much, as long as total wages stay within the standard deduction. For 2026, a dependent child's standard deduction is the greater of $1,350 or their earned income plus $450, capped at $16,100. Wages of $7,800 (as in our example above) produce zero federal income tax for the child. The Kiddie Tax under IRC §1(g) does not apply to W-2 wages, only to unearned income like dividends and capital gains. The FICA withholding from the S corp phase does reduce the child's net paycheck. If you want to make the child whole, you can pay them a slightly higher gross wage to cover it, though that increases the employer's matching obligation too. Honestly, most families just absorb the withholding difference and move on. If the child is funding a Roth IRA, the total contribution cannot exceed their earned income for the year. At $7,800 in wages, the child could contribute up to $7,500 (the 2026 annual limit) to a Roth IRA. The Roth contribution itself does not appear on the child's tax return. The IRA custodian reports it on Form 5498. Filing a return is not legally required below the $16,100 threshold, but it is recommended any year the child contributes to a Roth, just to establish a clean paper trail. * * * ## A Note on State Payroll Taxes Federal exemptions and state exemptions are not always aligned. Some states follow federal FICA treatment for family employees; others do not. A few states have their own employment tax rules that apply regardless of the entity type. Before you finalize your structure, check your state's department of revenue guidance or ask your CPA. Getting the federal side right while walking into a state payroll tax problem is an expensive way to learn this lesson. * * * ## Ready to Set Up Payroll the Right Way? If you are managing a mid-year conversion and want to make sure your kids' payroll is handled correctly from day one, [Kids Payroll](https://kidspayroll.com) is built exactly for this. The app walks you through setting up compliant payroll for your children, whether you are running a sole prop, an FMC, or both. It tracks hours, generates pay stubs, and keeps the records the IRS expects to see. You can get started at [kidspayroll.com](https://kidspayroll.com). * * * ## Sources - [IRC §3121(b)(3)(A)](https://www.law.cornell.edu/uscode/text/26/3121) — FICA exemption for child employed by parent in sole prop - [IRC §3306(c)(5)](https://www.law.cornell.edu/uscode/text/26/3306) — FUTA exemption for child under 21 employed by parent - [IRS Publication 15 (Circular E), Employer's Tax Guide](https://www.irs.gov/pub/irs-pdf/p15.pdf) - [IRS Publication 929, Tax Rules for Children and Dependents](https://www.irs.gov/pub/irs-pdf/p929.pdf) - [IRC §73](https://www.law.cornell.edu/uscode/text/26/73) — services of a child taxed to the child - [IRC §63](https://www.law.cornell.edu/uscode/text/26/63) — standard deduction - [IRC §1(g)](https://www.law.cornell.edu/uscode/text/26/1) — Kiddie Tax - _Eller v. Commissioner_, 77 T.C. 934 (1981) * * * **Bottom line:** The day your S corp election takes effect is the day the FICA and FUTA exemptions stop applying to wages paid by that entity. Plan your conversion date deliberately, set up the Family Management Company before the S corp starts issuing paychecks, and keep documentation airtight. The exemptions are still available. You just have to route the wages through the right entity to claim them. _This article is for educational purposes only and is not tax or legal advice. Consult a qualified CPA before putting your kids on payroll._ ## Related Articles [Family Business ### Can I Pay My Child a Commission or Percentage of Sales Instead of an Hourly Wage? Yes, you can pay your child a commission or percentage of sales. The IRS cares about reasonable pay for real work, not whether you used an hourly rate. Here is how to do it right. Read article](/blog/pay-child-commission-percentage-sales/) [Family Business ### Can a Family Management Company Pay Kids in Multiple Businesses Owned by the Same Parent? A Family Management Company lets one entity employ your kids across every business you own, preserving FICA and FUTA exemptions and stacking the tax savings. Here is exactly how it works. Read article](/blog/can-a-family-management-company-pay-kids-in-multiple-businesses-owned-by-the-same-parent/) [Family Business ### How to Pay Kids in a Business When You Have Multiple Children at Different Ages Yes, you can pay multiple kids in your business at once. Here is how to set the right wage for each age, keep clean records for every child, and stack the tax savings across your whole family. Read article ](/blog/how-to-pay-kids-in-a-business-when-you-have-multiple-children-at-different-ages/) GUIDE #### Want the full 7-step playbook as a PDF? Get the same guide my readers use to set this up correctly the first time. Sent to your inbox in 60 seconds. 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