What is a family management company and why is it used to pay children?

A family management company is a parent-owned entity, typically a sole proprietorship or a partnership of the parents, that employs the owner's children and bills the operating business for their real services. It exists because the payroll-tax exemption for a child under eighteen applies to wages from a parent's sole proprietorship or parents-only partnership, not to wages paid by an S- or C-corporation. Real work and reasonable wages are required.

Key points

A family management company is a parent-owned sole proprietorship or parents-only partnership that employs the owner's children and bills the operating business for their services.
Wages of a child under eighteen are exempt from Social Security and Medicare tax only when the employer is a parent's sole proprietorship or a parents-only partnership.
An S-corporation or C-corporation is a separate legal person, so wages it pays directly to the owner's children do not qualify for the payroll-tax exemption.
The corporation's fee to the family management company must be an arm's-length charge for real services, and the children's wages must be reasonable for work actually performed.
Wages paid to children are deductible to the business, taxed at the child's usually lower rate, and count as earned income for a retirement account.

Why does the payroll-tax exemption depend on who the employer is?

Section 3121(b)(3)(A) excludes from Social Security and Medicare tax the wages of a child under eighteen employed by a parent, and section 3306(c)(5) excludes the wages of a child under twenty-one from federal unemployment tax. The regulations extend the exemption to a partnership in which every partner is a parent of the child. The exemption belongs to the parent as employer.

A corporation is a separate legal person, not the parent. When an S-corporation or C-corporation pays the owner's children directly, the wages are fully subject to payroll taxes, even though the shareholder is the parent. An owner whose business is a corporation therefore loses the exemption by paying the children through the corporation.

How does a family management company restore the benefit?

The parents form a sole proprietorship or a parents-only partnership with its own employer identification number, bank account, and payroll. That entity, not the corporation, employs the children. The corporation signs a services agreement with the family management company, pays it a fee for genuine services, and the family management company pays the children as its employees and issues their Forms W-2.

Because the children's employer is now a parent's sole proprietorship or a parents-only partnership, the under-eighteen exemption applies. The corporation deducts the management fee under section 162, the family management company reports the fee as income and deducts the children's wages, and the structure restores the benefit the corporate form would otherwise cost.

What rules still apply to the children's wages?

The ordinary rules for paying your children do not go away. The work has to be real: age-appropriate tasks the business genuinely needs, such as filing, cleaning, packaging, data entry, or social media help. The wage has to be reasonable, measured against what you would pay an unrelated person for the same tasks. The fee the corporation pays must be an arm's-length charge for the services actually provided, not an arbitrary amount designed to move money.

Done correctly, the wages are deductible to the business and shift income from the parents' bracket to the children, who are usually taxed at a much lower rate because the standard deduction shelters most of the wage. The children's earned income can also fund an individual retirement account in the child's name, starting a long compounding runway early.

What are the limits and risks?

The exemption ends at eighteen for Social Security and Medicare and at twenty-one for federal unemployment tax, so wages to older children carry full payroll tax. The family management company must have real substance: its own registration, agreement, invoices, and payroll. An entity that exists only on paper, with a fee that bears no relation to services, fails the economic substance and reasonable-compensation tests and invites disallowance of the corporation's deduction.

Spending a child's wages on ordinary parental obligations undercuts the whole position, so pay the wages into accounts in the child's name and keep job descriptions and time records. State child labor rules also apply. Because the structure depends on the entity form and the agreements being exactly right, an attorney should set up the family management company and the services agreement, and a CPA should model the fee, the wages, and the payroll treatment before anyone is paid.