IRS Tax Benefits of Employing Children in an S-Corporation Explained

Hiring your children can be a legitimate way to shift income to family members in lower tax brackets. The rules are different when the business is an S corporation, though, and many articles get this wrong. Here’s what an S corporation owner needs to know.

The Payroll Tax Exemption Doesn’t Apply to S Corporations

A sole proprietorship, or a partnership owned only by the child’s parents, can pay a child under 18 without Social Security and Medicare tax, and a child under 21 without federal unemployment tax. An S corporation can’t. Wages an S corporation pays your child are subject to the same payroll taxes as any other employee’s: 7.65% from the employer and 7.65% from the child, plus FUTA. See Tax Benefits of Hiring Your Children for the sole proprietor rules.

The Benefits That Still Apply

• A business deduction: reasonable wages for real work reduce the corporation’s income, which lowers the income passed through to you on your K-1.
• The child’s standard deduction: for 2026, a dependent child can earn up to $16,100 in wages with no federal income tax, according to the IRS. Earned income isn’t subject to the kiddie tax.
• Roth IRA contributions: earned income lets the child contribute to a Roth IRA, up to the lesser of their earnings or the annual limit.
• Retirement plan contributions: if the child is eligible under the company’s plan, they can make 401(k) deferrals.

Whether this saves money overall depends on your bracket. You’re trading income taxed at your marginal rate for wages that carry about 15.3% in combined payroll tax, so the strategy works best when your marginal rate is high and the child’s wages fall within their standard deduction. Run the numbers before setting it up.

Requirements the IRS Will Look For

• Real work: age-appropriate tasks that the business actually needs, such as filing, cleaning, social media or data entry
• Reasonable pay: what you’d pay an unrelated person for the same work
• Documentation: timesheets, a job description, and wages paid through regular payroll
• Payroll compliance: Form W-4, withholding where required, Forms 941 and 940, and a W-2 by January 31
• The money belongs to the child: deposit it in an account in the child’s name, not yours
• Child labor laws: federal and Alaska rules on age, hours and hazardous work

Alternatives

Some families use a separate management company taxed as a sole proprietorship or parent-owned partnership to employ the children and bill the S corporation for services. This can preserve the payroll tax exemption, but it must have real substance. Get advice before you set one up. Related: Form 1120-S Explained and Schedule H.

Get Help From Diehl CPA

Tax rules change often, and the right answer depends on your full financial picture. Diehl CPA, led by Mark Diehl, CPA, CFE, prepares returns and builds tax plans for investors, retirees and closely held businesses. Learn about our tax return preparation and investment tax planning services, or contact us to talk through your situation.

This article is general information, not tax or legal advice for your specific situation. Updated October 2026.