An S-corporation can put the owner’s child on payroll and deduct the wages like any other employee’s pay, but the payroll tax exemptions that make this move so attractive for sole proprietors do not carry over. The corporation is a separate legal entity, so it owes the full employer share of Social Security, Medicare, and federal unemployment tax on every dollar the child earns. The strategy still pays off for many families because it moves income out of the parent’s bracket and into the child’s, where the standard deduction usually wipes out federal income tax entirely.
Why the Sole-Proprietor Payroll Tax Break Does Not Apply
If you operated as a sole proprietor, wages to your child under 18 would be exempt from Social Security and Medicare, and wages to your child under 21 would be exempt from FUTA. That exemption exists because the parent is the direct employer. In an S-corp, the corporation is the employer, not you, and the family payroll tax break disappears.1Internal Revenue Service. Family Employees
The corporation withholds the employee’s half of FICA (6.2% Social Security plus 1.45% Medicare) and pays a matching employer share. Social Security tax applies to wages up to $184,500 in 2026.2Social Security Administration. Contribution and Benefit Base FUTA runs 6.0% on the first $7,000 of annual wages, though state unemployment credits generally cut the effective rate to 0.6%.3Internal Revenue Service. Topic No. 759, Form 940 – Employers Annual Federal Unemployment (FUTA) Tax Return State unemployment insurance layers on top, with wage bases ranging from $7,000 to over $78,000 depending on the state.
When the Math Still Works
Every wage dollar reduces the S-corp’s net income, which otherwise flows through to your personal return and gets taxed at your marginal rate. If you sit in the 24% or 32% bracket, shifting $12,000 to a child who owes no federal income tax on it produces net savings even after the roughly 15.3% combined FICA hit. The higher your bracket, the wider the gap; if you are in the lowest brackets, the FICA cost can swallow most of the benefit.
Making It a Real Job
The IRS does not object to hiring your child. It objects to fabricated jobs and inflated paychecks. Everything below is about proving the employment is genuine.
Real Work the Business Actually Needs
Wages have to be for services that are ordinary and necessary to the business, the same standard that governs any deductible business expense.4Office of the Law Revision Counsel. 26 USC 162 – Trade or Business Expenses Filing, data entry, cleaning, social media, mailings — tasks you would otherwise pay someone to do or handle yourself. Vague duties like “helping around the office” do not survive audit. Write a specific job description before the child starts, and keep records of what got done each pay period.
Reasonable Pay
The rate must match what you would pay an unrelated person for the same work locally.5Internal Revenue Service. Meaning of Reasonable Compensation Paying a 14-year-old $50 an hour to shred documents will not hold up. Check local job listings or Bureau of Labor Statistics wage data for the occupation and save the research. Age, skills, and experience factor in; a teenager with no work history should not command trained-assistant rates.
Age and Labor Law
Federal law sets 14 as the minimum age for most non-farm work. Children 14 and 15 face strict hour limits: no more than 3 hours on a school day, 18 hours in a school week, 8 hours on non-school days, and only between 7 a.m. and 7 p.m. (9 p.m. from June 1 through Labor Day).6U.S. Department of Labor. Fact Sheet #43 – Child Labor Provisions of the Fair Labor Standards Act (FLSA) for Nonagricultural Occupations At 16 and 17 the hour caps lift, but hazardous work stays off-limits. State laws often go further and may require a work permit before the child starts.
Onboarding Paperwork
Treat the child like any outside hire. Complete Form I-9 to verify identity and work authorization.7U.S. Citizenship and Immigration Services. I-9, Employment Eligibility Verification Have the child fill out Form W-4 so the corporation withholds correctly.8Internal Revenue Service. Topic No. 753, Form W-4 – Employees Withholding Certificate Skipping either form undermines the arrangement.
Payroll Mechanics
Every payment runs through the S-corp’s formal payroll on the same schedule as other employees. Checks or direct deposits come out of the corporate bank account. Cash payments or transfers from a personal account destroy the paper trail.
The S-corp files Form 941 quarterly to report wages and withheld taxes, including the child’s.9Internal Revenue Service. About Form 941 – Employers Quarterly Federal Tax Return At year end, issue a W-2 and transmit copies via Form W-3.10Internal Revenue Service. About Form W-3 – Transmittal of Wage and Tax Statements Deposit the pay into an account in the child’s name, not yours. An account held only in the parent’s name undercuts the argument that the child actually received the compensation.
Keep employment tax records for at least four years after the tax was due or paid, whichever is later.11Internal Revenue Service. Employment Tax Recordkeeping Because family arrangements draw closer scrutiny, six years is safer. Save signed timesheets, task descriptions, deposit confirmations, the job description, and the market research you used to set the rate.
How the Child’s Wages Are Taxed
Wages from the S-corp are earned income on the child’s return, and earned income gets two important breaks.
The Standard Deduction Absorbs Most or All of It
A dependent’s standard deduction generally equals earned income plus a small inflation-adjusted amount, capped at the regular single-filer standard deduction. For 2026 that cap is $16,100.12Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 A child earning $14,000 owes zero federal income tax. The 7.65% employee FICA still comes out of the paycheck, but nothing at the income tax level.
Kiddie Tax Does Not Reach Wages
The Kiddie Tax attacks unearned income — interest, dividends, capital gains — to stop families from shifting investment income to kids. Wages are earned income and fall outside it entirely.13IRS. 2025 Instructions for Form 8615 – Tax for Certain Children Who Have Unearned Income The child’s wages are taxed at the child’s own rate, which is usually zero after the standard deduction.
Filing
The child files Form 1040 if gross income exceeds the dependent standard deduction threshold. Even below that level, filing is worthwhile whenever federal income tax was withheld — it is the only way to get that money back.
The 2% Shareholder Trap on Fringe Benefits
This is where many owners get tripped up. Anyone owning more than 2% of the S-corp is treated as a partner rather than an employee for fringe benefit purposes.14Office of the Law Revision Counsel. 26 U.S. Code 1372 – Partnership Rules to Apply for Fringe Benefit Purposes The 2% test uses constructive ownership, so a parent’s stock is attributed to the child. If you own 100% of the S-corp, your child is treated as a 100% shareholder for fringe benefit purposes, even though the child owns no stock.
Most tax-free fringe benefits available to regular employees stop being tax-free for the child. De minimis perks, no-additional-cost services, working condition benefits, and retirement planning services all lose their exclusion.15Internal Revenue Service. Employer’s Tax Guide to Fringe Benefits – Publication 15-B Health insurance follows a special path: premiums the S-corp pays for the child go into W-2 Box 1 wages subject to income tax, though they are excluded from FICA, and the child may then claim an above-the-line deduction for them.16Internal Revenue Service. S Corporation Compensation and Medical Insurance Issues
The Roth IRA Payoff
The largest long-term benefit has nothing to do with this year’s return. Any child with earned income can contribute to a Roth IRA. The 2026 limit is $7,500 or the child’s total taxable compensation, whichever is less.17Internal Revenue Service. Retirement Topics – IRA Contribution Limits A parent or guardian opens a custodial Roth IRA and manages it until the child reaches the age of majority (18 or 21 depending on the state).
The compounding math is what makes this remarkable. A $7,500 contribution at age 14 has roughly 50 years to grow before traditional retirement age; at a 7% average annual return, that single contribution grows to over $200,000, all withdrawable tax-free. A few high school years of contributions can build a six-figure retirement foundation.
The child does not have to deposit their actual paycheck. You can gift the contribution amount, as long as the child has at least that much in earned income for the year. The limit is tied to earnings, not the source of the deposited funds.
What Happens If the IRS Challenges It
If the IRS finds the wages unreasonable or the employment not genuine, the wage deduction gets disallowed. The S-corp’s income goes up, flows through to your return, and you owe income tax at your marginal rate plus interest from the original due date.
An accuracy-related penalty of 20% of the underpayment can apply if the disallowed deduction created a substantial understatement (generally the greater of 10% of the correct tax or $5,000).18Office of the Law Revision Counsel. 26 U.S. Code 6662 – Imposition of Accuracy-Related Penalty on Underpayments If the IRS treats the setup as negligent, the same 20% penalty applies without the substantial understatement threshold.
The recharacterized payment may also be treated as a constructive distribution from the S-corp to the owner. That reduces stock basis first, and anything above basis becomes capital gain. The child’s W-2 and payroll filings still exist, so amended returns are needed to clean up. Cutting corners on documentation or inflating the rate can easily cost more than the tax savings the arrangement was supposed to deliver.