Paying Your Kids From an S Corp: W-2, Payroll Tax, Cash Pay

Does my S corporation have to put my child on payroll and issue a W-2?

Generally yes. When an S corporation pays a child for work, the corporation is the employer and the pay is wages. The "no payroll tax under 18" rule belongs to a parent's own business, not to a corporation, so Social Security, Medicare and federal unemployment tax (FUTA) apply to a child's pay at any age (next section). That shrinks the tax saving from paying a child.

The corporation files a Form W-2 for every employee, even a relative, when it withheld income, Social Security or Medicare tax (whatever the wages), or paid $2,000 or more in wages without withholding anything (IRS: Forms W-2 and W-3 instructions). The statute reaches an employer that was required to withhold, so failing to withhold does not remove the duty (26 U.S.C. 6051(a)). A Form 1099 does not avoid this: the IRS looks at the whole relationship and the right to direct and control the worker, not the form (IRS: Independent contractor or employee).

A case is more than routine when:

• The child, spouse or parent was already paid in cash or by transfer, this year or in earlier years.
• A child owns shares, so wages and distributions have to be kept apart.
• There is no record of what the work was.
• The work or the payroll accounts involve a state other than the corporation's home state.
• A relative lives outside the US, has no Social Security number, or may not be authorized to work in the US.
• An IRS or state letter has arrived.

If family members were already paid outside payroll, go to the cash and transfers section below. That case, most of all when it reaches back to earlier years, can call for professional review before any return is filed (corporate tax help).

Gather first:

• What each family member did, on which dates, for how many hours
• Every payment: date, amount, who received it, how it was sent
• How the books recorded each payment (wages, distributions, loan, other expense)
• Wages and officer pay on each Form 1120-S, and any payroll return ever filed
• Each person's Social Security number and any Form W-4
• The corporation's EIN and any state payroll account numbers

Why doesn't the under-18 exemption apply when the employer is an S corporation?

The under-18 exemption from Social Security and Medicare tax depends on who the employer is. In a business, pay for a child under 18 is free of Social Security and Medicare tax, and pay for a child under 21 is free of FUTA, only when the child works for their parent in the parent's own sole proprietorship, or in a partnership where every partner is the child's parent (IRS: Family employees). A corporation is a separate employer. Publication 15 treats the child as working for the corporation, not for the parent (IRS: Publication 15, section 3), and the statute's exception covers only a child employed by "his father or mother" (26 U.S.C. 3121(b)(3)). The regulations say service for a corporation is outside both exceptions, and a partnership qualifies only if every partner is the child's parent (26 CFR 31.3121(b)(3)-1; 26 CFR 31.3306(c)(5)-1).

An LLC with a valid S corporation election is treated as a corporation from the election's effective date (IRS: Form 2553 instructions), so the same answer applies. An LLC that has not elected corporate status is covered in hiring your children.

Which taxes apply to my child's wages from an S corporation?

All four federal payroll taxes can apply: income tax withholding, Social Security, Medicare and FUTA. The child's share of Social Security and Medicare comes out of the child's pay; the corporation pays its own matching share and all of the FUTA.

An exempt Form W-4 stops income tax withholding only; the wages stay subject to Social Security and Medicare tax, and the exemption must be renewed by February 15 each year (IRS: Publication 15).

Does an S corporation have to run payroll for a spouse or parent too?

Yes. A spouse or parent who works for an S corporation is, like a child, treated as working for the corporation, so the corporation withholds income tax and Social Security and Medicare tax and also pays FUTA (IRS: Publication 15, section 3). The IRS says the same for a parent who works for a corporation even if the child controls it (IRS: Family employees).

The comparison that matters is with an individual employer. A spouse's pay in the other spouse's own sole proprietorship is subject to income tax withholding and Social Security and Medicare tax but not FUTA (IRS: Publication 15). Inside a corporation, FUTA applies too.

If one spouse is the only shareholder, nothing changes: the corporation is still the employer of the other spouse and the children. A family member who is also a shareholder and works in the business is a shareholder-employee, and the corporation must pay reasonable compensation for those services before it makes non-wage distributions (IRS: S corporation compensation). For the owner's own pay, see S corporation owner salary.

Can the S corporation deduct what it pays my child?

Yes, when the pay is a reasonable amount paid purely for services the child actually performed for the business. The regulation says an amount paid as compensation but not in fact as the price of services is not deductible, and reasonable pay is what like enterprises ordinarily pay for like services under like circumstances (26 CFR 1.162-7). The form or method of fixing the pay does not decide deductibility.

What makes the pay real:

• A real job the business needs, within the child's age and ability. State child-labor limits are in hiring your children.
• A rate in line with what the business would pay a non-family worker for the same work.
• Records made at the time: duties, dates, hours, who gave the task, what was produced.
• Payment through payroll on regular pay dates, not a lump sum sized to a tax target.

Wages not reported elsewhere on the return go on Form 1120-S line 8 for a non-officer and line 7 for an officer; wages already in cost of goods sold are not deducted again (IRS: Form 1120-S instructions). The same instructions warn that when a shareholder's family member provides services without reasonable compensation (pay that is too low), the IRS may adjust the items taken into account by that person and the shareholders (26 U.S.C. 1366(e)). Pay above what is reasonable is not deductible as pay.

We already paid the kids in cash or by transfer without payroll: what now?

Pay for work is wages whether or not payroll ran. The regulations say the name of the payment is immaterial and the medium, cash included, is also immaterial (26 CFR 31.3121(a)-1). So the corporation may have payroll returns it never filed. When the payments were pay for work, those returns are what the rules require. The work behind each payment decides how it is treated:

In order:

1. Payroll for current pay stops the gap from growing. See setting up payroll.
2. List every payment from bank statements: date, amount, person, method, and the work.
3. Sort the list with the table above, year by year.
4. Check who the employer was on each payment date. Pay before the S election took effect was paid by whatever the business was then. A sole proprietorship, or a single-member LLC that had not elected corporate status, follows the individual-employer rules in hiring your children. An incorporated business, or an LLC that had already elected corporate treatment on Form 8832, stays under the corporation rules on this page even before the S election (26 CFR 301.7701-3; IRS: Form 2553 instructions).
5. Settle gross or net. Establish whether each payment was gross pay or an agreed take-home amount, and whether the person will repay the employee tax share. If the corporation pays that share and does not recover it, the IRS treats it as additional wages when paid, not as more pay for the earlier year (IRS manual 4.23.8; IRS guidance, not law). Work this out before calculating the corrections.
6. File what the wages require. For each quarter in which wages were paid, that is Form 941, or Form 941-X if a Form 941 was already filed for that quarter; for each year in which the Form 940 tests are met, Form 940 (amended if one was filed); and an original Form W-2 to the person and to the Social Security Administration, or Forms W-2c and W-3c if a filed W-2 left these wages out (IRS: W-2 instructions). The Form 941-X instructions cover an employer that never filed because it treated workers as nonemployees: a Form 941 for each delinquent quarter. For earlier years, Form 941-X corrects income tax withholding only for an administrative error or where section 3509 rates apply, so income tax that was never withheld is not entered as withheld; read fixing a payroll mistake first.
7. Correct the books and Form 1120-S. Amounts the books call distributions, loans or other expenses will not match the W-2s, and the wage lines, shareholder records and Schedule K-1 distributions may change.

The corporation is liable for the employee share of Social Security and Medicare tax and the income tax that should have been withheld (26 U.S.C. 3102(b); 26 U.S.C. 3403). Income tax withholding is figured from the pay dates and the Form W-4 on file, and from the single rate when none was given (IRS: Hiring employees), so a child with no tax due for the year can still have had withholding owed. Where section 3509 does not apply, an employee's payment of that income tax can relieve the corporation of it, though penalties can still apply (26 U.S.C. 3402(d)); the IRS handles the relief with Forms 4669 and 4670 (IRS manual 4.23.8). Section 3509 reduced employer rates switch that relief off (26 U.S.C. 3509(d)(1)(C)) and may or may not fit pay to family; see contractors who may be employees.

Time does not run out on a return that was never filed: where no return was filed, the IRS may assess the tax at any time (26 U.S.C. 6501(c)(3)). Where a return was filed for the period, the usual limit is three years from April 15 of the following year, and fraud has no limit (26 U.S.C. 6501(a), (b)(2), (c)(1)). Late returns and late tax carry penalties and interest (IRS: Publication 15; IRS: Form 941 instructions), and a responsible person who willfully fails to collect or pay over the employee taxes can be personally liable for the trust fund recovery penalty (26 U.S.C. 6672); see behind on payroll taxes and trust fund recovery penalty.

Professional review is worth having when payments span more than one tax year, payroll accounts are in more than one state, the books call the payments distributions, loans or other expenses, or an IRS letter has arrived. See corporate tax help and bookkeeping help.

Can we call those payments gifts or distributions instead?

No. A label does not change what a payment is. Money paid for work is wages whatever it is called (26 CFR 31.3121(a)-1). If no work was done, the payment is not pay for services and is not deductible as pay (26 CFR 1.162-7), but that does not make it a gift or a distribution by default.

A distribution is a payment on shares. An S corporation may have only one class of stock (IRS: S corporations), which the regulation treats as met when every share confers identical rights to distribution and liquidation proceeds (26 CFR 1.1361-1(l)). A child who owns no shares has no right to a distribution, so the payment is not a distribution to the child. Whether it is instead treated as a distribution to a shareholder who passed the money on depends on the facts and needs review; the regulation says an ostensible salary paid by a corporation may be a distribution on its stock (26 CFR 1.162-7(b)(1)).

If the child does own shares, a payment sized to the child's work is compensation, not a distribution. Whether other payments to a shareholder-child affect the one-class-of-stock rule is the subject of unequal S corporation distributions.

What do I set up and file for a child employee?

A child employee needs the same setup as any employee: a Social Security number, a Form W-4, and the corporation's payroll accounts and returns. For the full first-employee setup, see setting up payroll.

Before the first pay date:

1. Get the child's name and Social Security number (IRS: Publication 15).
2. Get a signed Form W-4, effective with the first wage payment, and complete Form I-9 for every individual hired (IRS: Hiring employees).
3. Report the new hire to the state registry and register for any state withholding and unemployment accounts; each state sets its own rules (IRS: Publication 15; IRS: State government websites).

A due date on a Saturday, Sunday or legal holiday moves to the next business day, and either return may be filed ten days later when all its tax was deposited on time (IRS: Form 941 instructions; IRS: Form 940 instructions).

Is it worth paying my child through the S corporation?

It can pay, with a smaller margin than in a parent's own business, where a child under 18 owes no Social Security, Medicare or FUTA. The corporation's deduction saves the owner tax, at the owner's rate, on the wages plus the employer taxes. The cost is both shares of Social Security and Medicare, FUTA, any state unemployment tax, and the payroll work.

Whether it pays depends on:

• The owner's tax rate. The deduction is worth less at a lower rate, and payroll taxes cost the same at any rate. Other effects, such as the qualified business income deduction, also change the result.
• The amount. Fixed costs, such as a payroll service and state unemployment tax, weigh more on small pay.
• The work. Pay that cannot be tied to real work is not safe to deduct.
• The child's own tax. Pay within the child's standard deduction, covered next, usually adds no federal income tax on the child's side.

The example below runs the numbers for one case. Run your own with your actual rate.

How does my child's own tax return work?

The wages are the child's income, even if a parent receives the money (IRS: Publication 501). A child who can be claimed as a dependent has a limited standard deduction: the greater of $1,350 or earned income plus $450, but never more than the $16,100 single amount (IRS: Rev. Proc. 2025-32; IRS: Topic 551). A dependent child with only wages therefore generally owes no federal income tax on wages up to that deduction.

A child with income tax withheld may file to get it back (IRS: Publication 501). Whether a child counts as a dependent, whether a child must file, the kiddie tax and Roth IRA contributions are in hiring your children.

Example

All amounts are in US dollars and illustrative. Rates are the federal rates above, with the full state unemployment credit; state taxes, payroll service fees and the qualified business income deduction are not included.

A teenager paid for a summer job

A Texas S corporation, owned entirely by one parent, pays the owner's 16-year-old US$6,000 over the summer for filing and social media work. The corporation needs a payroll account and files a W-2.

• Social Security and Medicare withheld from the child: US$459. The corporation adds US$459, plus FUTA of US$36.
• The child takes home US$5,541 before any income tax withholding. With no other income, the child's standard deduction is US$6,450, so no federal income tax is due.
• In a parent's sole proprietorship, the same job owes none of the US$954 in total payroll tax.

The corporation deducts US$6,495 (wages plus its US$495 of payroll tax). At an owner's federal rate of 24%, the deduction saves about US$1,560 of income tax against US$954 of payroll tax, so the family comes out about US$605 ahead on tax. At 12% the deduction saves about US$780, and the family ends about US$175 behind. These figures change with the owner's actual rate, state taxes and the qualified business income deduction; they are an illustration, not a forecast.

Two owners send their children transfers with no payroll

Two owners, spouses holding 50/50, send their children US$4,000 each by transfer. There is no payroll and no record of work.

The children own no shares, so the payments are not distributions to the children. How they are treated for the owners depends on the facts.

• If the children did real work and it can be shown, and each US$4,000 was gross pay: the US$8,000 is wages. The corporation owes payroll returns for the quarters paid, W-2s, employer Social Security and Medicare of US$612, FUTA of US$48 (higher if the state unemployment tax went unpaid), the US$612 employee share it did not withhold (if it pays that share and does not recover it, that is additional wages, taxed again), and any penalties and interest.
• If no work was done: the payments are generally not wages, and how they are treated instead needs a CPA's review. Payments with no work behind them may be treated as distributions to the owners, and that is checked against their equal 50/50 shares.

The missing work record weakens the deduction.

A spouse who works part time

An owner's spouse works part time for the S corporation and is paid US$20,000. The corporation, not the owner, is the employer, so the family exceptions do not apply. The pay goes through payroll like any employee's: US$1,530 of Social Security and Medicare is withheld from the spouse, and the corporation pays a matching US$1,530 plus FUTA of US$42. In the owner's own sole proprietorship, the same spouse would owe no FUTA.

Different for you?

• Family members were paid outside payroll for part of a year or for several years, or your books call the payments distributions, loans or other expenses: a professional sorts out which years need payroll filings or corrections, whether the payments now count as wages, how the books, Form 1120-S and shareholder records show them, and whether the arrangement is worth keeping. See corporate tax help, bookkeeping help and S corporation catch-up books.
• A payroll letter arrived, W-2s are missing, or payroll was run wrong: see behind on payroll taxes, late contractor and employee tax forms and fixing a payroll mistake.
• A relative paid lives or works outside the US, or has no Social Security number or work authorization: the answer depends on where the work is done and the person's status; see cross-border tax help.
• This is the corporation's first employee: see setting up payroll.
• Your own salary is also missing from payroll: see S corporation owner salary and S corp payroll never run.
• The business is a sole proprietorship or a parents-only partnership, or you need child-labor, kiddie tax or Roth IRA rules: see hiring your children.
• A child owns shares, or distributions are unequal: see unequal S corporation distributions.