CPA for Business Owners: What Has to Be True Before You Put Your Kids on Payroll

Two recommendations land in the same meeting all the time. Elect S corporation status to cut self-employment tax. Put the kids on payroll to shift income into a bracket that pays nothing. Both are real. What rarely gets said is that the first one deletes the best part of the second.

There is a way to get it back. It involves a second entity, it is written into the regulations rather than invented around them, and it is not worth doing until your numbers say it is. A CPA for business owners should be walking through all three of those points before anyone runs payroll.

How does this actually save money?

You pay your child a real wage for real work. The business deducts it. The child reports it as earned income on a return of their own.

For 2026, a dependent's standard deduction is the greater of $1,350 or earned income plus $450, capped at the single standard deduction of $16,100 (Rev. Proc. 2025-32). A child with $16,100 of wages and no other income owes no federal income tax on it, and the kiddie tax does not reach this because section 1(g) applies to unearned income. Two children, and roughly $32,000 moves off your return onto two returns that owe nothing federally. State income tax is its own question.

Does my business structure change the answer?

It changes it more than anything else on the list.

Wages paid to a child under 18 in a parent's sole proprietorship, or in a partnership where all the partners are parents of that child, are not subject to social security and Medicare tax. The FUTA exemption runs to age 21. Both disappear when the employer is a corporation, and the IRS is explicit: those payments are subject to withholding, social security, Medicare and FUTA regardless of age, even when the parent controls the corporation.

An S corporation is a corporation for this purpose. The owner who elected S corp status to save self-employment tax gave up the family payroll tax exemption on every dollar they pay their children, and was probably never told.

Can I get the exemption back?

Yes, because the exemption follows the employer rather than the business. Change who employs the children and the answer changes with it.

That is what a separate management company does. A parent owns a second entity, structured as a sole proprietorship, a single-member LLC, or a partnership in which every partner is a parent of the child. It performs genuine administrative work for the operating company under a written agreement, bills a management fee for it, and employs the children to do that work.

This is not a workaround. Treasury Regulation 31.3121(b)(3)-1(d) addresses it directly. A single-member LLC is normally treated as a corporation for employment tax purposes, which would defeat the whole thing, so the regulation carves it out: that entity is not the employer for the family employment exclusion, and the owner is. The rule looks through the LLC to the parent on purpose. Which parent owns it is a design decision rather than a formality.

What does this look like in real numbers?

An illustrative example. Rounded figures.

An e-commerce owner in the 32% federal bracket for 2026. Two children doing genuine work: product photography, packing orders, keeping listings current. Each paid $16,100, so $32,200 in total.

Paid by a sole proprietorship: deduction worth about $10,300 at a 32% rate. Social security, Medicare and FUTA on those wages, zero.

Paid by the S corporation directly: the $10,300 does not change. Social security and Medicare now apply at 7.65% each side, about $4,900. The business deducts the employer half, so call the real cost near $4,100.

Paid by a management company the S corp pays $35,000 to: the S corp deducts $35,000. The management company pays out $32,200 in wages that carry no social security, Medicare or FUTA, and keeps $2,800 of profit. That $2,800 is self-employment income to the parent, roughly $400 of self-employment tax.

About $4,100 of cost becomes about $400.

When is the second entity the wrong move?

Set the fee too high and you manufacture a tax that did not exist. If the same S corp paid the management company $50,000 instead of $35,000, the leftover profit jumps to $17,800 and the self-employment tax on it to roughly $2,500. Those dollars came out of S corporation profit, which bears no self-employment tax at all. The fee should track the real cost of the services, because every dollar above that converts untaxed pass-through income into taxed self-employment income.

The fee also has to be defensible on its own terms. Section 162(a) allows a deduction for a reasonable allowance for compensation for services actually rendered, and that test applies to the management fee and to the children's wages separately. A wage that would be absurd for a stranger doing the job does not become reasonable because a family member is doing it.

The machinery is real. A second EIN, a payroll registration, a separate bank account, its own books, a written management agreement, and another filing every year. The example above saves roughly $3,700 a year. There is a level of profit below which that is a great deal of structure for a small number, and the honest way to find it is to run your figures rather than a rule of thumb.

Age runs on a schedule. The social security and Medicare exemption ends the day a child turns 18, FUTA runs to 21, and state unemployment and youth employment rules do not always follow the federal ones. The example also sets aside the qualified business income deduction, which cuts both ways and has to be modeled rather than assumed.

The limit owners assume away is the biggest one. None of this reduces self-employment tax on the operating business, and a management company is no fix for owner compensation set by guesswork. Different problems, different tools.

What to do this week

Find your marginal bracket on last year's return. Write down what each child actually does and how many hours it takes. Then check your entity, because that single fact decides whether you are looking at a payroll-tax-free wage or a wage that costs an extra 15.3 cents on the dollar.

If you have an S corp and the numbers carry a second entity, the structure is available and well supported. Sizing it is what a CPA for business owners earns their fee on, and September beats December for it. For more on sequencing owner-level decisions before year end, see our earlier writing on year-end planning for business owners.

We're currently offering our Tax Savings Blueprint, a forward-looking planning service for the 2026 tax year. We review your returns and current-year documents, project where your 2026 return is heading, and walk you through it on a call, so you leave with a clear picture of your tax situation, the strategies available to you, and a set of actions to put in motion. Schedule a free intro call to learn more.

This is for general educational purposes and isn't personalized tax advice. Every situation is different, talk with your CPA before acting on any strategy discussed here.