Roth IRA for Kids? Yes, and Here’s Everything You Need to Know.
- Tyler Weerden
- Jul 1
- 29 min read
Updated: 4 days ago
There are dozens of articles that provide the same surface-level details regarding custodial Roth IRAs. My goal with this article wasn’t to provide yet another general summary. I wanted to dive deep on the practical aspects and really focus on the questions that I’ve been asked by many parents. As always, I am a financial planner but I am not your financial planner. I am not an accountant and this article is by no means tax advice. Consult with a professional before making financial, tax, and legal decisions.
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Start With Why
Can investing early make your child a tax-free millionaire? Absolutely. But this is about more than money, it’s about time and freedom. The older I get, the more I value these two things a lot more than money. Helping your child start down the path of tax-free wealth building could help them reach financial freedom long before traditional retirement age.
There are four variables that will determine how long it takes someone to reach financial freedom.
1 – How much they spend.
2 – How much they save and invest.
3 – The rate of return their money earns (and how much they keep, after taxes and inflation).
4 – How much time they allow that money to grow.
Starting a Roth IRA for your child can significantly jumpstart their path to financial freedom. You’re directly affecting #2, #3, and #4 for them. I know this sounds dramatic, but I truly believe this could change the trajectory of their life.
When I ask people what they wish they changed about their financial journey, the vast majority say, “I wish I started sooner.” You can help your child not say that.
Let’s look at two investors:
Tom – Started investing at age 15, contributing roughly $208/month ($2,500/year) until age 50. Assuming an 8% annualized growth rate and a 1% increase in contributions each year, after 35-years Tom ends up with roughly $498,000.
Jerry – Started investing at age 25, contributing roughly $416/month ($5,000/year) until he retires at 50. Assuming an 8% annualized growth rate and a 1% increase in contributions each year, after 25-years Jerry ends up with $414,000.
Tom invested a total of $104,137. Jerry invested a total of $141,217. Despite Tom investing $37,000 less than Jerry, he ends up with $84,000 more at age 50. How? The power of compounding over those 10 additional years.
Roth IRA – The 10,000 Foot View
Step #1 – Dollars contributed to a Roth IRA are “post-tax”, meaning they’ve already been subject to income tax. You’re funding your Roth IRA with money from your bank account, that landed in your checking or savings after being taxed by your employer. There is no tax deduction for your Roth IRA contribution.
Step #2 – Dollars in the Roth IRA grow tax-free. You don’t pay tax annually on dividends, interest, or capital gains.
Step #3 – Dollars (earnings/growth) can be withdrawn from the Roth IRA tax and penalty-free if they are “qualified”, which means you: (1) First funded any Roth IRA at least 5-year ago and (2) are either 59 ½, disabled, dead, or qualify for the first-time homebuyer exception ($10,000 lifetime limit).
The “Roth” itself is not an investment. When you hear the word “Roth”, just think of it as a tax wrapper that shields your investments from future tax. An Individual Retirement Account (IRA) is a saving/investing account that is not sponsored by your employer. Employer plans include the federal Thrift Savings Plan (TSP), 401(k), 403(b), and 457. Just like with IRAs, these employer plans usually include a Roth wrapper option in addition to traditional pre-tax wrappers.
Perhaps the best candidates for Roth IRAs are young people, who may be short on income but long on time.
Triple Tax-Advantaged
The term “triple tax-advantaged” is usually associated with my other favorite account, the Health Savings Account (HSA). But for certain taxpayers, their Roth IRA can also provide a trio of tax-savings. This is one of the few instances where it pays to be young and broke.
Let’s talk about the 0% federal tax bracket.
Wait...isn’t the lowest marginal federal tax bracket 10%? Technically, yes.
However, there’s a $15,750 standard deduction for single filers in 2025 ($31,500 for those who file Married Filing Joint and $23,625 for filers who are Head of Household).
So, if your child earns $15,750 or less, they’ll owe $0 in federal income tax. Their $15,750 taxable income is reduced to $0 by the standard deduction. This means that their Roth IRA contribution will be (1) free from federal income tax on the way in, (2) the money will compound and grow tax-free, and (3) come out tax-free as a qualified distribution (triple...tax...advantaged – boom).
Here’s a basic illustration on Form 1040 showing $15,750 of W-2 income (line 1a) being reduced by the $15,750 standard deduction (line 12), resulting in $0 taxable income (line 15).
CAUTION: Please note, even if your child pays 0% federal tax, they may owe state tax, payroll tax, or self-employment tax (more on this below).
Is There an Age Limit?
No. Whether you’re 75-days-old or 75-years-old, you can contribute to a Roth IRA (as long as you have taxable compensation/earned income – more on this below).
Are There Income Limits?
Yes – Income limits are based on the minor child’s income, not the parents.
Too Much Income?
This could complicate things, but most likely isn’t an issue for your minor child. In 2025, if a single tax filer has $150,000 of Modified Adjusted Gross Income (MAGI), the amount they can contribute to a Roth IRA is reduced. Once their MAGI reaches $165,000, they can’t directly contribute anything to a Roth IRA. This “problem” can typically be solved by executing a “backdoor” Roth IRA contribution/conversion, but again, this is probably not an issue for your minor child.
Too Little Income?
Not a problem.
The 2025 IRA contribution limit for those under age 50 is:
(1) $7,000, or
(2) The total amount of taxable compensation, whichever is LESS.
For example:
-Sally earned $10,000 working at McDonalds in 2025. She can contribute $7,000 to her Roth IRA since that’s the maximum contribution limit and she has taxable compensation of at least $7,000.
-Sam earned $4,000 working at Subway in 2025. He can contribute $4,000 to his Roth IRA since that’s the total taxable compensation he earned. Remember, the maximum contribution is the annual limit or total taxable compensation, whichever is LESS.
Please note that the $7,000 contribution limit is for ALL of the IRAs owned by the individual taxpayer. So, if you have a traditional IRA at Vanguard, a Roth IRA at Fidelity, and a Roth IRA at Charles Schwab, the maximum you can contribute across all of those IRAs is still $7,000.
Now, for the important part, taxable compensation / earned income.
Taxable Compensation / Earned Income
TLDR: Your child must earn money from employment in order to make a Roth IRA contribution in their name. The income can come from W-2 employment, 1099 contract work, or self-employment not reported via 1099 (more details on these employment options below).
The payments can come in the form of cash, check, or electronic transfer.
Regardless of the source of income or method of payment, documentation is key.
IRS Publication 590-A tells us that individuals can contribute to an IRA as long as they (or their spouse) have “taxable compensation”. When looking at your child’s Roth IRA eligibility, we’re most likely going to find taxable compensation in the form of regular W-2 earnings or self-employment income (mowing lawns, shoveling snow, dog walking, babysitting, tutoring, washing cars, etc.).
Overseas Income
If you’re stationed overseas and your minor child earns taxable compensation, they may still qualify to make a Roth IRA contribution. There is no restriction to opening the custodial Roth IRA account while overseas, but there could be restrictions for contributing to the account.
Basically, there has to be taxable compensation “leftover” after taking all of the allowable deductions, exclusions, exemptions, etc. If using the Foreign Earned Income Exclusion (FEIE), those excluded dollars will not show up as Adjusted Gross Income (line 11) on the 1040. This means if the FEIE reduces their income to $0, they most likely will not be able to make an IRA contribution.
This is a different concept than reducing their taxable income to $0 via the standard deduction. The FEIE removes dollars "above the line", while the standard deduction removes income "below the line". The line we're talking about is Adjusted Gross Income, line 11 on the 1040.
Chapter 5 of IRS Publication 54 tells us that contributions to IRAs are limited to the lesser of the annual limit or your, “compensation that is includible in your gross income for the tax year. In determining compensation for this purpose, don’t take into account amounts you exclude under either the foreign earned income exclusion or the foreign housing exclusion.”
Employment: W-2 + Parents Do Not Own the Business
If your child earns income via W-2, and you (his/her parents are not the employer) this is the simplest scenario. The employer will handle the payroll taxes and whatever appears in Box 1 of the W-2 is what they can contribute to their Roth IRA.
If your child isn’t working for an unrelated W-2 employer, see the other employment options section below the tax return filing section. These other options include your child working for themselves, or your child working for your family business.
Is a Tax Return Required?
“My kid only earned $500 mowing lawns. Do we really need to file a tax return for them?”
“My kid only worked a few shifts at Dunkin. Do we really need to file a tax return for them?
If my child was working in any capacity (W-2, self-employed, or otherwise), I would be filing a tax return in their name regardless of whether or not they’re legally required to file a return.
Why?
(1) If they have a W-2 job, income taxes were most likely withheld by the employer. However, their income may be low enough to where no tax was actually due. The amount of tax your employer withholds DOES NOT equal your actual tax liability (it could be more; it could be less). So, what does it mean if your child had more tax withheld than they actually owed? They’re entitled to a tax refund! You’re going to be their hero when that money rolls in. Not filing a return in this scenario leaves a nice tip for the tax man. Don’t do that.
(2) To document their earned income and start a clean tax trail of earned income matched up with Roth IRA contributions. Here’s how.
-Contribute $1,000 to a Roth IRA ($1,000 is just for this example).
-Show $1,000 worth of taxable compensation on a tax return.
-Receive Form 5498 from the brokerage (Vanguard, Fidelity, Schwab, etc.) showing that $1,000 was contributed to a Roth IRA.
You Type-A folks who want everything to match up perfectly should love this. This creates a nicely documented paper trail if anyone were to ever ask questions. I personally would create a cloud-based folder the includes all related paperwork and a spreadsheet for tracking. Here’s an example of the headings I would use on the spreadsheet.
But...the question is, do you HAVE to file a return? This topic is hotly debated in various forums and on social media. However, the IRS provides pretty clear guidance in IRS Publication 501.
Test #1 – MUST FILE: If your child is a single tax filer, under 65, and had gross income above the standard deduction ($14,600 in 2024, $15,750 in 2025), they must file a return.
Test #2 – MUST FILE: If your child is claimed as a dependent, under 65, not blind, and had:
1. Unearned income more than $1,300 ($1,350 in 2025)
2. Earned income more than $14,600 ($15,750 in 2025)
3. Gross income was more than the larger of
a. $1,300 ($1,350 in 2025) or
b. Your earned income (up to $14,150 (2024) / $15,750 (2025)) plus $450
Test #3 – MUST FILE: If your child had $400 or more in self-employment net earnings. What does this mean? They weren’t paid by a W-2 employer but they did perform services (babysitting, lawn mowing, dog walking, etc.) and were paid at least $400 after deducting expenses.
Does Your Child Actually File the Return?
No. The burden is not on your 9-year-old to create a TurboTax account and experience the joys of adulthood on their own. You as the parent can file for them. You can also sign the return for them if they’re unable to.
Paper vs. E-File
In certain situations, you may have to file a physical tax return due to your child’s age and/or identity validation. Yes – this means you’ll have to print it and snail mail it to the IRS. If any money is owed, you’ll need to mail an old-school check (good luck explaining that relic to your child).
In order to file electronically, the IRS requires you validate your return, by providing your prior year’s Adjusted Gross Income (AGI).
First time filers UNDER age 16 (with no prior returns): Will most likely need to paper file.
First time filers OVER age 16: The IRS says that you can enter "0" as the prior-year income to validate.
If you are going to E-File, you can use one of the big box software providers (TurboTax, H&R Block, etc.) or check out the following IRS resources:
2. All 8 IRS Trusted Partners
3. IRS Find a Trusted Partner tool. This free tool allows you to select your filing status, age, state of residency, and type & amount of income, and it will provide a list of trusted partners. According to the tool, the trusted partners will allow you to file free federal returns, and some will allow you to file free state returns.
Here’s an example of the results of the IRS Find a Trusted Partner tool for a 15-year-old with $10,000 worth of W-2 income, living in Virginia.
Parent's Return Rejected
Parents – file YOUR return first and make sure you list your child as a dependent (as long as they qualify).
File your CHILD’s return AFTER you file yours. Make sure that the box that says, “Someone can claim: You as a dependent” is checked on their return.
I have never experienced this first-hand, but multiple sources have said if this is done incorrectly, the PARENT’S return will be rejected because without the child checking their dependent box, the IRS thinks nobody should be claiming them.
Whose Money is it Anyway?
So, you finally got your child working and they’ve got $500 bucks burning a hole in their pocket. They’ve dreamt about all the things they could do with this $500...and none of those dreams involve buying an index fund in their Roth IRA.
Cue the “parental match”.
Money is fungible, meaning your $1 bill is the same as my $1 bill. A $1 bill could be combined with $19 other dollars to equal an interchangeable $20 bill. $1 held by me is the same as $1 held by you. This is not the same for unique, non-interchangeable assets like cars, houses, or non-fungible tokens.
Be careful when you tell your kids about this concept...this will somehow further support their belief that your money is their money, and their money is their money.
What does this mean for their Roth IRA?
This means that you can take $500 of YOUR money and contribute that to THEIR Roth IRA, leaving them to use their $500 on...whatever kids are buying these days. Nowhere does it say that the unique $500 from their paycheck must fund their Roth IRA. The IRS just says that they need taxable compensation in that amount, to support the contribution.
Maybe you can teach them about the concept of an employer match early, and give them a dollar-for-dollar match on the amount they’re willing to put in. As long as you stay below their taxable compensation, in this example $500, the split on whose money is actually funding the Roth IRA is up to you.
Opening a Custodial Roth IRA
A minor cannot open their own Roth IRA since they legally cannot enter into a contract. This means you have to serve as the “custodian” and open a Custodial Roth IRA for them. Technically, any adult can serve as the custodian. Grandparents, a family friend, rich uncle, etc. You can open the custodial account at whichever company you want (Vanguard, Fidelity, or Charles Schwab for example).
Just like opening any other investment account, you’ll need the basics (name, date of birth, SSN, address) of both the adult custodian/adult owner and the minor owner. This isn’t difficult and you can probably have the entire account opening process completed in 10 minutes.
With Vanguard for example, you’ll simply click on “open a new account”. You’ll then click on “Education, or general investing for a minor.” You’ll then be able to specifically select “Minor IRA” instead of “general investing brokerage.” Remember, with a general investing brokerage account, that money will not grow tax-free and will not be withdrawn tax-free (unless capital gains are recognized in the 0% long-term capital gains bracket). Either way, what you’re looking for is a custodian Roth IRA / Minor IRA. If you’re not sure about how to open this account with the company of your choice, search YouTube or call the company to make sure you’re not opening a taxable account.
When you open the custodial Roth IRA, you are the temporary manager of this account, which is “for the benefit” of your child. The account may actually be titled something like, “[Parent’s name] Custodial Roth IRA FBO [Child’s Name]” or “[Parent's Name] Custodian FBO [Child's Name] Roth IRA". As the custodian, you’ll help your child log in, make contributions, pick investments, download tax documents, and everything else that’s required.
Every dollar that goes into the account belongs to the minor and is irrevocable. When the minor reaches their “age of majority”, which in most states is age 18, the account is 100% theirs. At this point, they can do whatever they want with the account. Hopefully, you’ve taught them some financial sense and they understand the goal is to let this thing compound tax-free for decades. Depending on the company, the “former minor owner” may simply become 100% adult owner, or they’ll have to rollover the custodial Roth IRA to their own adult (non-custodial) Roth IRA.
Something that nobody likes to think about – the death of a child. With a custodial Roth IRA, the minor is the beneficiary. If they pass away before reaching age of majority, the assets would pass to their estate. Once they become an adult, they can then name primary and contingent beneficiaries like any other account owner.
Investment Options
Keep it simple. For the love of God, stop listening to people trying to sell you hybrid “insurance-investment” products for your child. Products that the salesperson earns a nice fat commission on. Is all insurance bad? Nope. Individuals who have people relying on them for income should have a simple term life insurance policy to provide future income, pay-off debt, and cover final expenses in the event of their death.
If I had a minor child and were opening a custodial Roth IRA for him/her today, I would be buying one fund.
A low-cost, passively managed, Total U.S. Stock Market index fund. That’s it. Nothing else.
*This is not an investment recommendation or advice. This is simply what I would do based on my hypothetical child’s situation.
Why?
(1) Historically, higher returns. This account is their tax-free bucket...we want this thing to go, “to the moon” as the “expert” day traders say. Investing their Roth IRA in lower volatility, lower returning cash and bonds is not going to be the best use of this account. Notice I didn’t say lower RISK bonds and cash. For individuals with a longer time horizon, cash and bonds can actually be very risky while not being volatile? Why? The silent killer known as inflation.
(2) Historically, higher volatility. This account is for retirement. A minor’s time horizon, even if retiring early in their 40’s or 50’s, is decades away. Minors have high risk capacity, meaning they have the financial ability to withstand stock market ups and downs. If the account value gets cut in half, their standard of living isn’t going to change. The Bank of Mom & Dad is still going to make payments to provide shelter, food, clothing, etc. In fact, experiencing a large U.S. stock market decline and being able to show them how the fund eventually recovers could be an extremely powerful lesson. A market downturn will also show them that they’re buying funds at a lower cost (“on sale”) when this occurs. You could reinforce some sound principles in this scenario.
(3) Easy to explain. For those who love triple-leveraged funds, inverse ETFs, and options straddles, take yourself back to 5th grade for a moment. What’s going to be easier to explain? A complex product/strategy that most adults wouldn’t understand, or telling your child that they’re a part-owner in the company that drops packages at their door daily. Or the company that makes their iPhone and their favorite car. A total stock market index is going to contain companies that your child will recognize and be excited to own.
What about international?! I personally have international stock exposure and believe that it can provide diversification. However, for your minor child, let’s start as basic as possible. With these smaller amounts of money, will holding 5% emerging markets and 15% developed markets really make a huge difference? Probably not. It will just add more stuff to explain when their brains are already going to be overwhelmed. One step at a time.
Withdrawals (“Qualified Distributions”)
If you have a Roth IRA, or plan on opening one for your child, you must understand the withdrawal rules.
Rule #1 – Contributions can always be taken out tax and penalty free, at any age, for any reason. Maybe keep this fact to yourself so that your child isn’t tempted to use their Roth IRA to fund the newest Playstation purchase.
Rule #2 – The IRS has ordering rules which state Roth IRA contributions come out first, before any conversions or earnings are withdrawn. If you distribute $5,000 from a Roth IRA that has a total account value of $6,000 ($3,000 equals contributions & $3,000 equals earnings) you will be distributing $3,000 worth of contributions and $2,000 worth of earnings. *This assumes that you only have this one Roth IRA with $6,000. If you have multiple Roth IRAs, they are “aggregated” and viewed as one giant Roth IRA bucket in the eyes of the IRS.
How do we know if the earnings are tax and penalty free? The “qualified distribution” test.
Rule #3 – Qualified Distributions = NO TAX & NO PENALTY. This is a two-prong test:
Prong #1: 5-years have passed since January 1st of the calendar year in which you made your very first Roth IRA contribution to any Roth IRA, AND
Prong #2: You are either:
(a) 59 ½
(b) Disabled
(c) Dead (in which case your beneficiary is withdrawing the money)
(d) Withdrawing up to $10,000 (lifetime limit) under the first-time homebuyer rules
Yes, there are many exceptions to the 10% early-withdrawal penalty (birth/adoption, health insurance premiums while unemployed, terminally ill), however, if you want money TAX & PENALTY FREE from a Roth IRA, you MUST satisfy both prong #1 and either a, b, c, or d of prong #2.
Wedding? Trip of a Lifetime?
Since contributions can be withdrawn at any age for any reason, tax & penalty-free, certain life events could technically be funded by distributing Roth IRA contributions. Is this the best idea? No. Roth money needs to be left alone so that it can experience tax-free compounding for as long as possible. There are instances where it may make sense for retirees to recognize some tax-free Roth income to avoid other tax dominoes, but this is not the case for your minor child or someone in their 20s, 30s, or 40s.
Home Purchase?
Yes! Up to $10,000 worth of earnings can be withdrawn tax and penalty free at any age under the first-time homebuyer rules (26 U.S. Code §72(t)(2)(F)), as long as they first funded any Roth IRA at least 5-years ago. Remember, the earnings will come out after all contributions and conversions have been withdrawn.
College?
There is an exception to the 10% penalty if earnings are distributed for qualified higher education expenses (26 U.S. Code §72(t)(2)(E)). However, while exempt from the 10% penalty, earnings from the Roth IRA for qualified higher education expenses will still be added to taxable income.
If you really want to dive deep (like, really deep) into the Roth IRA distribution ordering rules, IRA aggregation, and the two five-year rules that apply to Roth IRAs, check out The Ultimate Guide to the Two 5-Year Rules for Roth IRAs.
Can a Roth IRA Affect Student Aid Eligibility?
Possibly.
Retirement account assets held by parents and students are not included for the Free Application for Federal Student Aid (FAFSA). Therefore, the mere existence of the Roth IRA should not negatively affect student aid eligibility.
Withdrawals from a Roth IRA count as “untaxed income” and will be part of the Student Aid Index (SAI) formula. This means that distributing tax-free Roth income can reduce financial aid.
Other Employment Options
Can’t I Just Pay My Kid to “Work” Around the House?
I’ve heard this more than a few times. “I’m going to pay my child $7,000 to do chores around the house and use that money to fund their Roth IRA.”
Great intent, but in the opinion of many accountants and financial planners (myself included), this fails the “taxable compensation” rule outlined in IRS Publication 590-A. Your child is not paying tax on their allowance, gifts, or chore money, and therefore it’s not taxable compensation.
For those minor children with an UTMA/UGMA brokerage account generating interest and dividends, this income also doesn’t count as taxable income. If you’re not sure what counts for taxable compensation to contribute to an IRA, review IRS Publication 590-A, Table 1-1 (above).
Now, to be fair, I can’t find any official IRS resource, publication, or revenue ruling that explicitly states that money paid for chores can’t be used to fund an IRA, however, the requirement for “taxable compensation” seems pretty clear.
There is a 2001 SFgate.com article where someone asked if they could pay their son, “$2,000 a year for making his bed and doing chores around the house so he can make the maximum annual contribution to a Roth individual retirement account and invest tax-free?” The response from then IRS spokesman Jesse Weller was, “This would not be a bona fide business relationship...and therefore the payment would not be earned income.”
So, if paying your child to rake leaves, shovel snow, or weed the garden isn’t going to allow a Roth IRA contribution, what can you do?
Get someone else to pay them!
Here are the options:
(1) Help them/convince them to get a W-2 job if they are legally allowed to.
(2) Your child can work for themselves.
(3) Your child can work for your business.
“I’ll Just Start a Business”
Much easier said than done.
Starting a legitimate business and creating the proper employer-employee relationship is not a task I would undertake simply to create an avenue for a Roth IRA contribution. This isn’t something you “just” do. It’s going to require time and effort.
The IRS has seen plenty of people with a hobby try to say that their hobby is a business, so that they can deduct expenses. IRS Tax Tip 2022-57 outlines some factors to consider, including but not limited to:
The taxpayer carries out activity in a businesslike manner and maintains complete and accurate books and records.
The taxpayer puts time and effort into the activity to show they intend to make it profitable.
The taxpayer depends on income from the activity for their livelihood.
Losses are due to circumstances beyond the taxpayer's control or are normal for the startup phase of their type of business.
Taxpayer and their advisor have the knowledge needed to carry out the activity as a successful business.
Activity makes a profit in some years and how much profit it makes.
For you federal employees out there thinking you can just whip up a quick LLC, you also need to think about:
Authorization for outside employment/activity from your agency.
Disclosure of your outside employment/activity to government ethics/legal office.
Disclosure of your outside employment/activity to your security clearance office.
For those federal employees serving overseas, you’ll need to disclose, and get approval for your outside employment/activity from the Chief of Mission.
Employment: Child Working for Parent’s Business
In this scenario, both your business and your child may be able to save on taxes.
Potential savings:
Child saves: Federal income tax (via lower tax rate/standard deduction)
Child saves: FICA/payroll tax (with the proper business structure + child is under age 18 + child is a W-2 employee)
Parent/employer saves: Deduction for wages paid to the child (shifted income from the parent’s higher tax bracket to the child’s lower tax bracket by paying money to the child as a business expense on Schedule C).
Parent/employer saves: FICA/payroll tax (with the proper business structure + child is under age 18 + child is a W-2 employee)
Parent/employer saves: FUTA/Unemployment tax (when the child is under age 21).
Big picture – Income paid to your child from the business will provide a deduction to your business, and move income from you (at a higher tax rate) to your child (at a lower tax rate).
What about Social Security and Medicare tax typically paid by employers and employees?
IRS Publication 15 says that, “Payments for the services of a child under age 18 who works for their parent in a trade or business aren't subject to Social Security and Medicare taxes if the trade or business is a sole proprietorship or a partnership in which each partner is a parent of the child.”
Note that the exemption from Social Security and Medicare tax says “sole proprietorship or partnership in which each partner is a parent of the child.” This means that to qualify for the exemption, the business must be a sole proprietorship, single-member LLC (owned by a parent), or a partnership where both partners are the child’s parents. This strategy will not work for businesses structured as corporations or LLCs that elect to be taxed as a corporation (S Corp / C Corp).
In terms of federal taxes, IRS guidance on family employees says that, “payments for the services of a child are subject to income tax withholding regardless of age.” However, your child may be exempt from withholding any federal taxes if:
They had no federal income tax liability in the prior year, AND
They expect to have no federal income tax liability this year
More information on the withholding exemption can be found in the General Instructions on page 2 of the Form W-4.
What about unemployment tax paid typically paid by employers?
FUTA (Federal Unemployment Tax Act) requires the employer to pay 6% federal unemployment tax on the first $7,000 worth of income per employee. This is only paid by the employer, not the employee. For business that are structured as sole proprietorship, single-member LLC (owned by a parent), or a partnership where both partners are the parents, there is no FUTA tax for income paid to children under 21. Please note that this does not exempt the business from paying state unemployment tax.
Make sure this truly is legitimate. Will it pass the “smell test”.
Claiming that you paid your 4-year-old $7,000 for operating a forklift is going to be a hard sell. Paying your 3-year-old for website design may raise some eyebrows. Paying your child for “website modeling” but they don’t appear anywhere on your website seems fishy.
If you decide to employ your child, take a step back and look at it from the perspective of an auditor. If you’re a federal agent or other investigator reading this, think about building a case for trial. If you pay your child to appear on your website, take screenshots to show they actually were on the website. If you pay your child to complete a specific project, document the before and after with written reports and photos/video. Just like with report writing, if you didn’t document it, it didn’t happen.
Follow these rules to stay above board:
(1) Labor Laws
Know what federal and state labor laws apply to your situation (may vary by age and type of employment). Also, review the Department of Labor’s list of dangerous jobs that are off-limits.
(2) Employee-Employer Relationship
This doesn’t mean you need to bombard your 7-year-old with Microsoft Teams meeting invites and make them sit in a cubicle all day. Ask yourself, are there elements to this relationship that align with a typical employee-employer relationship, where the employer has the right to direct and control the employee.
Do you provide instruction/training to them? Are they assigned tasks? Do you provide tools and materials? Do they have a timesheet? Is there a formal job description? Are you paying them once for a single project or multiple times by the hour? Do they receive payment into their own bank account? Is there a W-2 from you to them. Is there a W-4 from them to you? IRS Revenue Ruling 87-41 notes, “That is, an employee is subject to the will and control of the employer not only as to what shall be done but as to how it shall be done.”
(3) Legitimate Work
26 U.S. Code § 162(a) says that business expenses, which includes salaries and compensation, must be “ordinary and necessary”.
Your child must be providing actual, bona fide, realistic services that are ordinary and necessary for your business. If you own a construction firm and pay your child to, “guard the office from space invaders”, that’s not going to fly. However, if you paid your child to shred paper, clean the office, or stuff marketing envelopes, that makes sense. Make sure it’s also age appropriate. Your 10-year-old may be great at math, but they probably shouldn’t be paid for accounting/bookkeeping. Ask yourself – are there any other businesses in the same field that pay someone to do this task? The Tax Adviser has a great article on this topic.
(4) Reasonable Wage
IRS Revenue Ruling 73-393 states, “Where the facts show that actual services are rendered by a taxpayer's child as a bona fide employee in the operation of the taxpayer's business, and that the compensation paid for such services is reasonable and constitutes an ordinary and necessary expense of carrying on such business, such wage payments are deductible as a business expense for Federal income tax purposes.”
What constitutes “reasonable” compensation? Exactly that, is it reasonable. Ask yourself – would I pay a stranger the same rate to do the same task? If your child worked 4 hours per month stuffing envelopes on Sunday mornings, and you paid them $7,000 for the year, you paid them about $145 per hour. If you’d pay a stranger $145/hour to stuff envelopes please send me an application immediately.
It wouldn’t be a bad idea to check Indeed or other employment sites to see what the going rate is for that job in your area. Take those job ads and save them in your child’s employment folder so that when the IRS asks how you determined that to be a reasonable wage, you have an answer.
(5) Document, Document, Document
If you own a business and you’re paying your children, you should be documenting this activity as if you hired someone off the street. Record exactly what they did for work (photos/videos of completed projects), what days they worked, how many hours, the pay rate, the instructions given, how tasks were completed, etc.
Employment: Child Working for Themselves
This option is my personal favorite. It’s never too young to get that entrepreneurial mindset going. Working alongside your child to help them start their own business, earn their own money, understand how taxes work, file their first return, and invest in a Roth IRA is going to teach them so many valuable lessons.
Self-employment income may come in the form of cash, check, 1099, Venmo, Zelle, or other electronic transfer.
Are they reallyyyyyyy in business?
If your child earns income from babysitting – they are in business.
If your child earns income from mowing lawns or shoveling snow – they are in business.
If your child earns income from walking dogs – they are in business.
According to the IRS. “Self-employment income is income that arises from the performance of personal services, but which cannot be classified as wages because an employer-employee relationship does not exist between the payer and the payee.”
Don’t let this scare you, or them. They’ll probably find this pretty cool once they realize they are a young business owner. While you’re at it, sit down and watch some Shark Tank. Who knows, maybe their business will blow up and they’ll help you retire sooner.
Once they have $400 or more in net earnings from self-employment, they’ll need to file a tax return (and in my opinion, should file even if they aren’t legally required to). This tax return aspect is going to provide additional lessons and will not be as burdensome as you think.
Self-Employment Tax
In this scenario where they work for themselves, they might have to pay self-employment tax.
For us W-2 working types, we don’t have to put much thought into payroll taxes that fund social programs like unemployment, Social Security and Medicare. Our employer takes care of the math and the payments.
The government requires your employer pay 6.2% of your salary into Social Security (on up to $176,100 worth of income in 2025 – known as the “wage base limit) and 1.45% for Medicare (on all income, plus a 0.9% additional tax for higher earners). Total paid by the employer = 7.65%.
The government also requires that you pay 6.2% of your salary into Social Security (on up to $176,100 worth of income in 2025) and 1.45% for Medicare. Total paid by the employee = 7.65%.
This means 15.3% total (7.65% x 2) is paid by employees and employers to cover Federal Insurance Contributions Act (FICA) taxes. If you don’t have an employer handling this, are you exempt from FICA tax? Not so fast.
This is where self-employment tax comes in.
With self-employment tax, the math matches FICA. Your child, as the self-employed individual, has to pay 15.3% self-employment tax; 12.4% for Social Security (6.2% x 2) and 2.9% (1.45% x 2) for Medicare. Why x 2? Because technically they are the employer and the employee. This equals exactly the 7.65% employer portion and the 7.65% employee portion we saw for FICA. Just like with W-2 folks, there is a 0.9% Medicare additional tax for self-employed individuals exceeding certain thresholds ($200,000 of income for single filers).
So, will they have to pay it?
We’re back to that magic $400 amount again. If their net earnings (after business deductions) is $400 or more, they’ll need to pay self-employment tax.
So, if they made at least $400, you (or your CPA, or your tax software) will figure out their net profit on Schedule C and use that amount on Schedule SE to calculate the self-employment tax. This amount of self-employment tax will fall under the “Taxes and Credits” portion of the form we’re all familiar with, the 1040.
How Much Is Self-Employment Tax?
This is much simpler to explain with an example.
Let’s say your child earned $1,200 gross income from mowing lawns for your neighbors. Your child spent $200 on gasoline for the mower. One client wanted their lawn raked before getting mowed, so your child went to Home Depot and bought a $30 rake. The client kept the rake and reimbursed your child for the cost.
So, what’s the net profit?
$1,200 gross income (-) $200 gasoline expense = $1,000 profit (reported on Schedule C).
Don’t throw the $30 rake payment in the income column, this was simply a reimbursement. The same concept applies for babysitters who pay for food for the kids they’re babysitting, and the clients reimburse them.
So, we have $1,000 net profit, how much is the self-employment tax.
Step #1 – 92.35% of their net profit reported is subject to self-employment tax. Why 92.35%? Because the government is generous and they’re giving you a break on 7.65%, which is normally paid by the employer (6.2% Social Security + 1.45% Medicare).
$1,000 net profit (x) .9235% = $923.50 earnings subject to self-employment tax.
Step #2 – Take the net earnings subject to self-employment tax and multiply that amount by 15.3%. Why 15.3%? The same thing we covered above – 12.4% (6.2% x 2) for Social Security and 2.9% (1.45% x 2) for Medicare.
$923.50 earnings subject to self-employment tax (x) .153 = $141.30 total self-employment tax.
Final Result: $141.30 self-employment tax on $1,000 net earnings, for an effective rate of 14.13%.
Deductible Amount of Self Employment Tax
There’s a small break with the 15.3% self-employed tax individuals must pay, and this tax break affects the allowable Roth IRA contribution.
Your child will deduct 50% of the self-employment tax paid. This 50% self-employment tax deduction is an “above the line” deduction (1040 line 10), which means it reduces their Adjusted Gross Income (1040 line 11). This is a deduction even before applying the standard deduction.
So, in our example above, you would have $1,000 net income reduced by $70.65 (50% of $141.30 self-employment tax), which gives us a final “taxable compensation” of $929. This means your child could contribute $929 to a Roth IRA.
Final Thoughts
I get that there is a LOT to digest in this article. Again, I did not want to provide yet another generic article that would leave you with more questions than answers. At the end of the day, it's worth doing the research and putting in the effort to fund a Roth IRA for your child. This is about propelling them towards financial freedom and empowering them to make sound financial decisions. Opening a Custodial Roth IRA could significantly impact their future. If your child is working, in any fashion, I would place this high on the “to do” list.
About the Author
Tyler Weerden is a fee-only financial planner and the owner of Layered Financial, a Registered Investment Advisory firm based in Arlington, Virginia. In addition to being a financial planner, Tyler is a full-time federal agent. He holds a Bachelor of Science degree, a Master of Science degree, passed the Series 65 exam, and is a Certified Fraud Examiner (CFE). Tyler is the sole Investment Adviser Representative at Layered Financial.
Prior to becoming a federal agent, Tyler served as a state trooper, local police officer, and was a member of the U.S. Army National Guard. He has served in both domestic and overseas Foreign Service assignments. Tyler has experience with local, state, and federal pension systems, 457(b) Deferred Compensation, the federal Thrift Savings Plan (TSP), Individual Retirement Accounts (IRAs), Health Savings Accounts (HSAs), and various investment options to include rental real estate.
Disclaimer
Layered Financial is a Registered Investment Adviser registered with the Commonwealth of Virginia and State of Texas. Registration does not imply a certain level of skill or training. The views and opinions expressed are as of the date of publication and are subject to change. The content of this publication is for informational or educational purposes only. This content is not intended as individualized investment advice, or as tax, accounting, or legal advice. Nothing in this article should be seen as a recommendation or advertisement. Layered Financial and its Investment Advisor Representatives have no third-party affiliations and do not receive any commissions, fees, direct compensation, indirect compensation, or any benefit from any outside individuals or companies. Although we gather information from sources that we deem to be reliable, we cannot guarantee the accuracy, timeliness, or completeness of any information prepared by any unaffiliated third-party. When specific investments, types of investments, products, or companies are mentioned, such mention is not intended to be a recommendation or endorsement to buy or sell the specific investment, solicit the business, or use that product. The author of this publication may hold positions in investments or types of investments mentioned in articles. This information should not be relied upon as the sole factor in an investment-making decision. Readers are encouraged to consult with professional financial, accounting, tax, or legal advisers to address their specific needs and circumstances.
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