If your business is a corporation, this article is not for you — an owner who works for their own corporation genuinely can be on its payroll, and none of what follows applies.

It is for the sole proprietor who moved $4,000 from the business account to the personal one last month and has been calling it a salary ever since.

The six words

Schedule C, line 26:

"Do not include salaries and wages deducted elsewhere on your return or amounts paid to yourself."

That is the whole rule. A sole proprietorship is not a separate person from its owner, so a payment between the two is a transfer between your left hand and your right. It is a draw. It is not a wage, not an expense, and not a deduction.

The corollary catches people the other way round: you are taxed on the profit, not on what you withdrew. Leaving money in the business account does not defer anything. A year that earned $70,000 and paid out $30,000 is still a $70,000 year on your return and on your self-employment tax.

The bookkeeping habit that prevents thisLabel the transfer "Owner's draw", never "Salary" or "Wages". The word in your accounting software is where this misunderstanding starts, and once a year of transfers is sitting under a wages heading, somebody has to unpick it.

The door the same rules open

Now the part most parents running a business have never been told. From the IRS page on family help:

"Payments for the services of a child under the age 18 are not subject to social security and Medicare taxes."

and

"Payments for the services of a child under age 21 are not subject to FUTA tax."

Two different thresholds, doing two different jobs. Both apply where the child works in "the parent's sole proprietorship or a partnership in which each partner is a parent of the child."

So a wage paid to your own 16-year-old, for real work, does three things at once:

Effect On $8,000 of wages
Deduction on line 26 → lower profit Income tax and self-employment tax fall
Self-employment tax saved (15.3% of 92.35%) $1,130.36
Social security and Medicare on the wage $0 — exempt under 18
FUTA on the wage $0 — exempt under 21

For comparison, the same $8,000 paid to an unrelated 25-year-old carries $1,224 of combined social security and Medicare between employer and employee. Under 18, in a parent's sole proprietorship, that is simply not owed.

The condition that makes it real

Everything above rests on one thing, and it is not the age.

The work has to be real, and the pay has to match it. A wage is deductible because it bought services the business needed, at a price it would have paid a stranger. Filing, packing orders, cleaning equipment, running the social accounts — all genuine work a business pays for.

Paying a child $8,000 for work that did not happen, or paying four times what the job is worth, is not a deduction that happens to be aggressive. It is a draw with a W-2 attached to it, and the exemptions above do nothing to protect it.

Keep what you would keep for any employee: what they did, the hours, the rate, and the reason that rate is what an outsider would have cost.

And it does not survive incorporation

The exemption is written for a parent's sole proprietorship, or a partnership where every partner is a parent of the child. Incorporate, and the child becomes an ordinary employee of an ordinary employer — social security, Medicare and FUTA all apply.

That is worth knowing before an entity change, because it is a cost that moves quietly.

What hiring anyone actually starts

Line 26 is not a line you fill in and forget. Employment reporting begins with the first payment: the Schedule C instructions note that in most cases you are required to file Form W-2 for each employee, with the General Instructions for Forms W-2 and W-3 covering the rest, alongside withholding and deposit obligations.

That is the real difference between line 26 and line 11, contract labor. A contractor needs a W-9 and possibly a 1099-NEC. An employee needs a payroll. And which one you have is decided by the working relationship, not by which is less work.

The summary

  1. You cannot pay yourself. The transfer is a draw and the return does not see it.
  2. You are taxed on profit, not on withdrawals.
  3. A child under 18 in a parent's sole proprietorship escapes social security and Medicare; under 21, FUTA.
  4. Only for work that happened, at a price you would have paid anyone.
  5. Hiring starts a payroll, on the first payment, not at year end.

The first one costs people nothing but a misunderstanding. The third one is worth over a thousand dollars a year and almost nobody uses it.

Common questions

Can I pay myself a salary from my sole proprietorship?
Not as a deduction. Schedule C line 26 is explicit: "Do not include salaries and wages deducted elsewhere on your return or amounts paid to yourself." Money you move from the business to your personal account is a draw. It changes nothing on the return.
Then how do I get taxed on what I take out?
You are not taxed on what you take out — you are taxed on the profit, whether or not you take it. Net profit from Schedule C carries to your return and to self-employment tax regardless of how much stayed in the business account.
Can I put my spouse on the payroll?
A spouse working in the business can be doing so in several different ways with different tax treatments, and the answer turns on the arrangement rather than the label. It is one to settle with a preparer before the first payment, not after.
Can I hire my child?
Yes, and the payroll taxes are treated differently. The IRS: "Payments for the services of a child under the age 18 are not subject to social security and Medicare taxes" when the child works in the parent's sole proprietorship or a partnership in which each partner is a parent of the child.
Is there a second age threshold?
Yes. "Payments for the services of a child under age 21 are not subject to FUTA tax." So 18 is the social security and Medicare line and 21 is the unemployment tax line.
Does that exemption survive if I incorporate?
No. The rule is written for a parent's sole proprietorship, or a partnership where each partner is a parent of the child. A corporation is neither, and the exemption does not follow you into one.
What makes the wage deductible?
The work. A wage is deductible because it buys services the business actually needed at a price it would have paid someone else. Paying a child for work that was not done, or far above what the job is worth, is not a deduction — it is a draw with extra paperwork.
What paperwork comes with hiring anyone?
Employment reporting starts immediately. The Schedule C instructions note that in most cases you are required to file Form W-2 for each employee, and the General Instructions for Forms W-2 and W-3 set out the rest.
Is this different from hiring a contractor?
Completely. A contractor goes on line 11 and may need a Form 1099-NEC at $2,000; an employee goes on line 26 with a W-2, withholding and payroll deposits. Which one you have is decided by the working relationship, not by preference.

This article is for educational purposes only and does not constitute tax, legal, or financial advice. Consult a qualified tax professional about your situation.

Official sources