Paying Your Kids Through an LLC or S Corporation: Roth IRA Benefits and Payroll Tax Planning

One of the most overlooked tax and wealth-building strategies for business owners is employing their children in the family business. When structured correctly, this strategy can create legitimate tax deductions, help children begin investing early through a Roth IRA, and potentially reduce payroll taxes depending on the business structure.

However, the rules differ significantly between an LLC taxed as a sole proprietorship or partnership and an S corporation. Understanding those differences is critical before running payroll.

Why Business Owners Pay Their Kids

There are generally three major goals when paying children through a business:

1. Create a legitimate business tax deduction

2. Shift income into a lower tax bracket

3. Generate earned income so the child can contribute to a Roth IRA

   
   

The long-term impact can be enormous: For example, if a child earns $7,000 annually from age 10 through age 18 and contributes that amount into a Roth IRA each year, decades of tax-free growth can potentially turn those contributions into hundreds of thousands of dollars by retirement.

The key is making sure the wages are legitimate, reasonable, and properly documented.

The LLC Advantage for Payroll Taxes

If the business operates as a sole proprietorship or a husband-and-wife LLC taxed as a partnership, there is a unique payroll tax advantage available. Under current tax rules, wages paid by a parent’s sole proprietorship to a child under age 18 are generally exempt from:

• Employment taxes ( Social Security tax, Medicare tax and even Federal unemployment tax (FUTA)) in many situations

The S Corporation Difference

An S corporation changes the payroll tax rules significantly. When an S corporation pays wages to the owner’s child, those wages ARE generally subject to:• Social Security tax• Medicare tax• FUTA

The business still receives a deduction for the wages, and the child can still fund a Roth IRA, but the family loses the payroll tax savings opportunity. This surprises many business owners because they often assume the rules work the same way across all entity structures and they do not.

Why Some Families Still Use an S Corporation

Despite the payroll tax downside for children’s wages, S corporations still provide substantial benefits in many situations. One major advantage is reducing self-employment taxes for the business owner.

So there is often a tradeoff:

• LLCs can be more favorable for employing children

• S corporations can be more favorable for owner compensation planning

The right answer depends on profitability, family goals, payroll levels, and long-term planning.

Documentation Matters

The IRS expects the child to perform legitimate work and receive reasonable compensation.

Important best practices include:

• written job descriptions

• timesheets

• payroll records

• age-appropriate tasks

• actual payment through payroll or bank transfer

• documentation supporting the wage amount

Paying a 9-year-old $40,000 annually as “Director of Operations” is unlikely to survive IRS scrutiny. However, paying children reasonable amounts for real work is both common and legitimate.