Paying Your Children
| Intro
Employing your children in your real estate business can be a highly effective tax and financial planning strategy. It allows you to shift income from your higher tax bracket to their lower (or nonexistent) one, while also teaching them financial responsibility and providing them with a head start on their own savings and retirement. This strategy is most effective when done correctly, with careful attention to tax laws and operational requirements.
| Requirements
To legally and effectively employ your child, the IRS requires that the employment relationship be legitimate and properly documented.
Legitimate Work: The child must perform real, age-appropriate work that is necessary for the business. This can include tasks like cleaning properties, managing social media, organizing files, or assisting with marketing materials.
Reasonable Compensation: The wages you pay must be a reasonable amount for the work performed, similar to what you would pay an unrelated individual for the same job. Paying an excessive wage could be seen as a disguised gift, which can lead to disallowed deductions and penalties.
Proper Documentation: You must maintain detailed records, including a job description, timesheets showing hours worked, and proof of payment (e.g., checks or bank transfers). You should also have the child complete a Form W-4 and, if applicable, a Form I-9.
State Requirements: State unemployment and payroll tax laws can vary significantly and may not offer the same exemptions as federal rules. Some states may require you to pay state unemployment taxes on your child's wages regardless of the parent-owned business exemption at the federal level and may also have their own specific child labor laws regarding work permits, hours, and prohibited occupations for minors. Always consulting your state's department of labor to ensure full compliance with all local regulations, as failing to do so could result in penalties and negate the intended tax benefits.
| Benefits
The primary benefits of this strategy are tax savings and the ability to help your child build wealth.
Tax Benefits for Parents: The wages paid to your child are a deductible business expense, which reduces your taxable income from your real estate portfolio or business. This can result in significant tax savings, especially if you are in a high tax bracket.
Tax Benefits for the Child: Your child can earn up to the standard deduction amount without owing any federal income tax. For 2025, this amount is $15,000. Additionally, the wages are considered "earned income," which allows the child to contribute to a Roth IRA, an excellent tool for long-term, tax-free growth. Contributions to a Roth IRA are not counted as an asset on the FAFSA, so this can be an excellent way to save for your child's future without negatively affecting their financial aid eligibility
Avoidance of Payroll Taxes (in specific cases): The most significant tax benefit often comes from the avoidance of Social Security and Medicare taxes (FICA).
Sole Proprietorship or Partnership (where only the parents are partners): If your real estate business is structured as a sole proprietorship or a partnership where only the parents are the owners, wages paid to a child under the age of 18 are not subject to FICA taxes (15.3%). The business also avoids Federal Unemployment Tax (FUTA) on wages paid to a child under 21.
S-Corporation or C-Corporation: In this scenario, there is no exemption for FICA taxes. Both the employer (the corporation) and the employee (the child) must pay their respective portions of Social Security and Medicare taxes. The business still gets the tax deduction for the wages paid, but the overall tax savings are reduced compared to a sole proprietorship.
| Operational Matters
The method of paying your child and the type of business entity you have will dictate the specific tax and operational requirements.
Payment Method: W-2 vs. 1099
Employee (W-2): For most scenarios, a W-2 is the correct and safest way to pay your child. An employer-employee relationship is generally established when the parent has control over the “what”, “when,” and “how” of the work performed. Using a W-2 ensures proper reporting and allows you to take advantage of the FICA tax exemption for a sole proprietorship or parent-only partnership.
Independent Contractor (1099): It is generally not advisable to pay your minor child via a 1099 unless they are truly operating as an independent business. If you pay your child with a 1099-NEC for contract work over $600, they are considered self-employed.
Self-Employment Tax: This means the child will be responsible for the full 15.3% self-employment tax on their earnings. This negates the FICA tax savings that are available under a sole proprietorship or partnership, making it a much less tax-efficient strategy.
No FICA Exemption: The FICA tax exemption for a sole proprietor or partnership only applies to a W-2 employee, not to a 1099 independent contractor.
Tax Filing and Withholding Requirements
Deductibility by Parents: Regardless of the entity type, the wages you pay are a deductible business expense.
Child's Tax Return: A child must file a tax return if their earned income is greater than their standard deduction (e.g., $14,600 in 2024). They also must file if they have self-employment income of $400 or more.
Self-Employment Tax via 1099: If paid via a 1099 and their net self-employment earnings are $400 or more, the child is required to pay self-employment tax (Social Security and Medicare) and file a Schedule C and Schedule SE with their tax return.
Operational Action Items
Employer Identification Number (EIN): You'll need an EIN to pay employees and file W-2s. You can obtain one easily from the IRS.
Payroll Software: While you could manage payroll manually, it's often more efficient to use a payroll service (like Gusto, Quickbooks or ADP) to handle W-2 generation, tax calculations, direct deposit, and applicable state tax withholdings and filings. If you don’t already use this software, the additional cost will offset the tax savings by typically $50-$200 per month.
State and Local Laws: Remember to also check for any state or local labor laws, particularly those related to minors, as they can vary. Some states may also have their own unemployment taxes that apply regardless of the federal exemption.
| Challenges
IRS Scrutiny: The IRS is aware of this strategy and may scrutinize it for abuse. Failing to meet the requirements of legitimate work, reasonable pay, and proper documentation can result in disallowed deductions and penalties.
Administrative Burden: While the tax savings can be significant, the administrative tasks of hiring and managing an employee—even a child—can be a burden, including maintaining timesheets and running payroll. See Operational Considerations above.
Legal Compliance: Ensuring compliance with both federal and state child labor laws is essential to avoid legal issues.
The Problem of Passive vs. Active: The IRS has a strict set of rules under passive activity loss limitations that generally prevent you from using losses from a passive activity (like rental real estate) to offset income from a non-passive or "active" source (like a W-2 job or an actively managed business).
If your rental business is generating a loss, that loss is considered "passive." However, the wages paid to your children are considered "active" income for them and a tax deduction for you. When you have a loss-generating rental business and want to use the wages you pay your child to increase that loss, you may not be able to fully deduct those expenses against your other, non-passive income if the rental activities are considered passive. This can create a situation where you are doing the legitimate work of paying your children, but the tax benefit is limited. This limitation can potentially be overcome with strategies such as Active Participation Rental Real Estate, Short-Term-Rentals, and Real Estate Professional Status.
The EIN and Entity Structure
You’ll use an EIN to issue W-2s, pay employment taxes (if applicable), and file your business tax returns. If your rental portfolio or real estate agent business is a single-member LLC taxed as a sole proprietorship, you would use a single EIN for both your rental activity and your payroll. A challenge arises if your properties are held in separate LLCs. Each will have their own EIN, requiring you to determine which entity is legitimately employing the child and manage the payroll for that specific entity.
