What is reasonable compensation for a child?

Why Reasonable Compensation Matters

For business wages to support a compensation deduction, the amount must be reasonable for services actually rendered. Genuine, taxable compensation is also central to an IRA contribution. That makes the rate important for two reasons:

• Legitimacy: Unreasonable pay suggests the employment isn't real
• Tax avoidance: Overpaying shifts more income to your child's lower tax bracket

If audited, you'll need to justify why you paid what you did. The question auditors ask:"Would you pay a non-family member the same rate for this work?"

How to Set and Support the Rate

Do not start with the standard deduction or IRA limit and work backward. Start with the job, identify the applicable wage floor, and collect evidence of what comparable work pays in the same place and period.

Hours limits are also fact-specific. Federal youth-employment rules, school-day rules, hazardous-work restrictions, and stricter state law can all matter. An app-generated age range is not a legal hours limit.

Factors That Affect Reasonable Compensation

1. The Work Itself

More skilled or difficult work justifies higher pay. A 14-year-old doing graphic design can reasonably earn more than one doing basic filing.

2. Local Market Rates

What would you pay someone else in your area? Rates in New York City differ from rural Kansas. Research local babysitter rates, lawn care prices, or entry-level wages for comparable tasks.

3. The Child's Experience and Reliability

A 12-year-old who's been helping in your business for two years and is highly reliable can reasonably earn more than one who's just starting.

4. Minimum Wage Considerations

The federal parental-employment exception addresses specified youth-employment restrictions; it is not a universal waiver of wage law. Coverage and exceptions vary, and state or local rules may be more protective. Check the current rules before setting the rate.

What's Unreasonable?

Too High

• Paying $50/hour for basic filing work
• Paying a 7-year-old the same as an adult professional
• Wages that conveniently max out the standard deduction exactly

Too Low

• A rate below an applicable federal, state, or local wage floor
• Payment that doesn't match the documented hours
• Token amounts that couldn't reasonably compensate for the work claimed

Documentation to Support Your Rates

If audited, you may need to explain why your rates are reasonable. Keep records of:

• Rate research: Screenshots of similar jobs on Care.com, Indeed, or local job boards
• Consistency: A regular pay rate that doesn't fluctuate wildly
• Job complexity: Written job descriptions showing what work justifies the rate
• Geographic factors: Note if you're in a high cost-of-living area

Common Mistakes to Avoid

• Working backward from the standard deduction: Don't set hours and rates to hit exactly $16,100
• Using age as the only input: Pay should follow lawful wage floors and the value of the actual services
• Ignoring the actual work: Pay should match tasks, not be arbitrary
• Dramatic increases: Going from $8/hr to $25/hr suddenly is suspicious

A Practical Approach

Here's a simple framework:

1. Research what similar work pays in your area
2. Confirm the applicable wage floor and choose a rate supported by the evidence
3. Give small increases as the child gains experience (like any employee)
4. Document why you set the rate you did
5. Be consistent: pay the same rate for the same work

Bottom Line

Use a lawful rate you can support with contemporaneous market evidence. The goal is genuine employment with accurate payroll and records, not a payment amount chosen to manufacture a tax result.

Learn more: How to Hire Your Kids: The Complete Guide

Sources

• IRS Publication 334: Employee pay and deductible business expenses
• IRS Family Employees: Family-employment tax treatment
• DOL State Minimum Wage Laws: Current state wage reference
• DOL State Child Labor Standards: State hours and youth-employment reference