Hiring Your Kids: The Legal Tax Strategy Alabama Business Owners Are Missing
The Strategy Most Alabama Business Owners Skip
Every year, Alabama business owners pay taxes they could legally eliminate. One of the most overlooked strategies involves a provision in the federal tax code that has existed for decades: the ability to hire your own children, deduct their wages as a business expense, and have them pay little to no federal income tax on that income.
This is not a loophole. It is not a gray area. The IRS explicitly addresses it in its guidance. The strategy works, and it works well, when implemented correctly. The problem is not legality. The problem is documentation, entity structure, and the details that separate a valid business arrangement from a paper transaction that invites scrutiny.
How the Numbers Work
The federal standard deduction for 2024 is $14,600 for a single filer. A child who earns up to $14,600 in wages from a parent’s business owes zero federal income tax on those wages.
At the same time, the business deducts the full amount paid to the child. For a business owner in the 32% federal tax bracket, that deduction is worth $4,672 in federal tax savings. Alabama has its own income tax as well, adding further savings on the state side.
The combination creates a position where the family unit keeps more of the same income, shifted from the parent’s high-bracket earnings to the child’s zero-bracket return.
The next step is even more valuable. A child with documented earned income can contribute to a Custodial Roth IRA, up to the lesser of their earnings or the annual limit ($7,000 for 2024). Roth IRA contributions grow tax-free. They can be withdrawn tax-free in retirement. And they pass to heirs without income tax.
Three years of contributions at $6,500 per year — ages 15 through 17, for example — is $19,500 invested. At a 7% average annual return over 48 years, that becomes approximately $502,000 by the time the child reaches retirement age. That figure does not account for contributions made beyond those three years, or for the additional tax-free growth from Alabama wages that exceed the Roth contribution limit.
What the IRS Requires
The strategy works only if the employment is legitimate. The IRS applies three primary tests:
- The work must be real. The child must perform actual services for the business. Paying a child for doing nothing, or for work that the business would never pay an outside employee to perform, fails this test.
- The work must be age-appropriate. A 6-year-old cannot be a marketing director. But a 6-year-old can model clothing for an apparel business, appear in promotional photos or videos, or be paid reasonable fees for use of their image. A teenager can manage social media, answer phones, file documents, assist at events, and perform dozens of legitimate administrative tasks.
- The pay must be reasonable. The wage paid must match what the business would pay an unrelated employee for the same work. Paying a child $14,600 per year for 5 hours of work per week at a rate far above market is a red flag.
Beyond these tests, documentation is the difference between a defensible position and an audit loss. A written employment agreement, a work activity log, and proper payroll records are not optional. They are the foundation of any defensible kids-on-payroll strategy.
Entity Structure Matters: The FICA Question
One of the most significant financial benefits of this strategy involves FICA taxes — Social Security and Medicare. Under federal law, wages paid by a sole proprietor or single-member LLC (taxed as a sole proprietorship) to their child under age 18 are exempt from FICA withholding. Neither the employer nor the employee owes the combined 15.3%.
That exemption does not apply to S-Corps or C-Corps. Because those entities are separate legal persons, they do not qualify. An S-Corp owner who pays their child directly through the S-Corp loses the FICA exemption entirely.
The solution many attorneys and CPAs use is a Family Management Company. The parent establishes a separate sole proprietorship that contracts management or administrative services to the S-Corp. The sole proprietorship employs the children and pays them for those services. Because the employing entity is a sole proprietorship, the FICA exemption applies. The S-Corp pays the management company, which then pays wages to the children.
This structure requires proper setup and documentation. Done incorrectly, it can look like a sham transaction. Done correctly, it is a legitimate and well-established planning technique.
Alabama-Specific Considerations
Alabama imposes its own income tax on wages, with a top rate of 5%. The standard deduction in Alabama differs from the federal standard deduction and is lower. This means that a child earning $14,600 may owe a modest amount of Alabama income tax even if the federal liability is zero.
Alabama also requires businesses that employ minors to comply with the Alabama Youth Employment Law, which sets minimum age requirements and work-hour restrictions for minors under age 16. A child under 14 cannot perform traditional employment in most commercial settings. For younger children used in marketing roles, the legal framework is different — they are engaged as models or performers, not as traditional employees in the IRS sense, though the documentation requirements still apply.
Working with an Alabama attorney and a CPA who understand both the federal tax rules and state employment law is the only way to implement this strategy correctly from every angle.
The Connection to Estate Planning
The kids-on-payroll strategy does not exist in isolation. The wealth it builds — inside a Custodial Roth IRA, for example — eventually passes to heirs. How it passes, and how much of it survives that transfer, depends on the broader estate plan.
A Roth IRA inherited by a non-spouse beneficiary under current law must be fully distributed within 10 years. Without planning, a large Roth IRA balance could force distributions during a beneficiary’s peak earning years, undermining the tax-free benefit. Proper planning accounts for this.
Additionally, the income a child earns and invests belongs to them, not to the parent. Parents who are also building their own estate plans need to coordinate how their assets and their children’s growing assets interact — particularly if trusts, special needs planning, or business succession are part of the picture.
An integrated approach, combining payroll strategy with trust planning and retirement account titling, produces better long-term outcomes than any one piece implemented alone.
Getting Started
The Alabama Kids on Payroll Kit at Key Law LLC provides the documentation framework: an employment agreement, a work activity log, and a step-by-step checklist covering entity considerations, tax filing, and Roth IRA setup. It is designed for Alabama business owners who want to implement this strategy correctly without starting from scratch.
For business owners who also need the legal side handled — entity formation, a formal employment agreement reviewed for their specific situation, or an estate plan that protects everything being built — Key Law LLC handles that work as well.
The strategy is available. The tax code allows it. The question is whether it gets implemented before another year of savings passes unused.
Questions about the Kids on Payroll strategy or how it fits into a broader estate plan? Schedule a consultation with Key Law LLC. The firm serves clients throughout Alabama from its Huntsville office.
Frequently Asked Questions
Is it legal to put your child on your business payroll in Alabama?
Yes. The IRS explicitly allows parents who own businesses to hire their minor children and deduct those wages as a business expense. The requirements are that the work is real, age-appropriate, documented, and compensated at a reasonable rate. Alabama follows federal standards. Sole proprietors and single-member LLCs also qualify for the FICA exemption on wages paid to children under 18.
How much can a child earn before owing federal income tax?
For 2024, the standard deduction is $14,600. A child who earns up to $14,600 from a parent’s business owes zero federal income tax. The business deducts the full amount. A business owner in the 32% bracket saves approximately $4,672 in federal taxes on that deduction.
What kind of work can a minor child do for a business?
The work must be real, age-appropriate, and necessary for the business. Younger children can serve as brand models in marketing materials. Older children can do clerical work, social media management, filing, event assistance, and other administrative tasks. The pay must match what an unrelated employee would receive for the same work.
Can a Roth IRA be funded with a child’s business wages?
Yes. A child with earned income can contribute to a Custodial Roth IRA up to $7,000 for 2024. Roth IRA contributions grow tax-free and pass to heirs without income tax. Even a few years of contributions during the teen years can compound to significant wealth by retirement age.
Do S-Corps qualify for the FICA exemption on child wages?
No. The FICA exemption applies only when a sole proprietor or single-member LLC employs their child. S-Corp and C-Corp owners who want the exemption typically set up a separate Family Management Company structured as a sole proprietorship to employ the children and contract services to the corporation.
What documentation is needed in case of an IRS audit?
A written employment agreement, a work activity log showing specific tasks and hours, regular payroll records, W-2 issuance, and proof of payment (bank records or cancelled checks). Records should be kept for at least seven years.
How does this strategy connect to estate planning?
The Roth IRA and other assets built through this strategy eventually pass to heirs. Without coordinated estate planning, the tax-free benefits can be reduced by forced distribution rules or poor account titling. An integrated approach combining payroll strategy, trust planning, and retirement account beneficiary designations produces the best long-term outcome.