There are different rules as it pertains to hiring your children and paying them a max of $12,000 annually for different types of businesses.

When the owners of a corporation hire their child, there are still payroll taxes like FICA to deal with. FICA tax may not have to be withheld on work performed by a child under the age of 18 while employed by a parent in an unincorporated business (sole proprietorship, single member LLC or a partnership where the only partners are the child’s parents).

However, there is no FICA or FUTA exemption for employing a child in an incorporated business (S or C Corp) or in a partnership that includes non-parent partners. In these cases, the children are subject to the same withholding rules that apply to all other employees.

In Part 1, we discussed how you DO NOT have to pay payroll taxes for employing your kids if your business is a sole proprietorship, a single-member LLC taxed as a disregarded entity, or an LLC taxed as a partnership and owned solely by you and your spouse.

But if your business is an S or a C corporation, or a partnership, the IRS’s rules are clear. You must withhold and pay payroll taxes on income given to your children.

So, are you stuck if your small business is set up as an S or C Corp? Or if you’re planning on switching to an S Corp like we normally recommend for maximum tax advantages? Well, it turns out there is a workaround — a way to get around this restriction utilizing a little creativity and a “hybrid” approach.

Instead of paying your children directly from your S Corp, you pay them out of a family management company. You can create this simple family management company as a Sole Proprietorship separate from your S Corp, and owned by yourself or your spouse. Its only purpose is to support the operations of your Corporation, which can include the scheduling and monitoring of jobs done by your child(ren) — and all the bookkeeping and documentation necessary to keep the jobs within IRS standards.

The family management company charges the Corporation a management fee for these services and can then pay your child — which removes them from your corporate payroll.

And since the family management company is a Sole Proprietorship owned by a parent, you, or your spouse, it falls under the IRS exemption where payroll taxes don’t have to be withheld. By following this workaround, you’ve found a way to truly pay your kids $12,000 per year tax-free using nothing but the IRS’s own rules.