Can I Invest in My Child’s Business Without Creating Tax or Legal Problems?

Parents often want to help their children succeed. Sometimes, that help is an investment in a child’s business. It’s a generous gesture, but it can lead to unintended tax consequences, family disputes, or legal headaches without careful planning.

If you're considering investing in your child's business, take the time to understand the risks and responsibilities. Done right, it can be a powerful act of support. Done poorly, it can trigger audits, lawsuits, or strained relationships.

Clarify Your Role: Gift, Loan, or Investment?

Start by defining your intent. Are you giving your child money with no strings attached? Are you lending the funds with the expectation of repayment? Or are you buying an ownership stake in the business?

Each approach has very different tax and legal implications.

A gift means you expect nothing in return. In 2025, the IRS allows you to give up to $19,000 per recipient per year without filing a gift tax return. A married couple can give $38,000 jointly. Anything above that amount must be reported to the IRS using Form 709, although no tax is due unless you’ve exceeded your lifetime exemption. As of 2025, that exemption is $15 million per person under the One Big Beautiful Bill Act (OBBBA), up from $13.61 million in 2024.

A loan must meet strict criteria. If you lend your child more than $10,000, the IRS generally requires you to charge interest, based on published Applicable Federal Rates (AFRs). The IRS may impute interest and treat it as a taxable gift if you don't. You also must document the loan with a promissory note and a repayment schedule. Otherwise, the IRS may consider it a gift.

An investment means you become an owner. That could mean taking shares in a corporation or a membership interest in an LLC. This raises questions about valuation, voting rights, and profit-sharing. It also means you’re assuming risk. If the business fails, your money may be lost.

Document Everything

No matter how much you trust your child, always put the arrangement in writing.

If you are making a gift, keep a clear record of the amount and the date. If it exceeds the annual exclusion, file a gift tax return.

If you are making a loan, use a formal loan agreement. If applicable, it should include interest, repayment terms, default clauses, and collateral. Sign, date, and treat it like any other business transaction.

If investing, ask your child for the business’s governing documents, like the operating agreement and corporate bylaws.

Review them with an attorney. Ensure your ownership rights are correctly reflected and your capital contribution is recorded.

Verbal agreements and handshakes may feel like family, but they do not stand up in court or with the IRS.

Avoid Stepping into Legal Quicksand

Some well-intentioned parents unknowingly violate securities laws by “investing” in their child’s startup. If your child raises money from multiple investors and offers equity or profit interests, the business may be subject to federal and state securities regulations. This is true even if it’s just “friends and family.”

You may also run afoul of IRS rules if the business is structured as an S corporation and you don’t qualify as a shareholder. For example, non-resident aliens cannot own S-Corp stock. Nor can partnerships or some types of trusts. If your investment disqualifies the business, it could lose its S-Corp status and face steep tax consequences.

If your child’s business is a professional entity, like a law firm or medical practice, you may not be allowed to own any interest unless you hold the same license. Many states prohibit non-licensed individuals from owning even a minority stake in a licensed professional entity.

Watch for “Family Attribution” Traps

The tax code includes many attribution rules that treat family members as a single economic unit. These rules can create unexpected problems.

Given the potential tax benefits for investors and entrepreneurs, it's important to understand the updated provisions regarding the Qualified Small Business Stock (QSBS) exclusion under IRC §1202. These changes could significantly impact investment strategies and tax planning, and it is important to note that certain types of businesses may not be eligible.

The OBBBA introduces a tiered system for Qualified Small Business Stock (QSBS) gain exclusion under IRC §1202 based on holding periods: 100% exclusion for stocks held over 5 years, 75% for those held for at least 4 years, and 50% for those held at least 3 years. The lifetime cap for exclusion remains greater than $10 million or 10 times the stock's basis, with the small business gross asset limit raised from $50 million to $75 million.

Family attribution rules apply, meaning stock acquired from related persons won’t qualify unless issued directly by the company for consideration, with violations leading to loss of exclusion eligibility.

Use Trusts or LLCs Cautiously

You might be tempted to invest through a family trust or LLC to protect the funds or simplify future estate planning. This can work, but it adds complexity.

Generally, grantor and testamentary trusts can be shareholders in an S corporation.  Other trusts may also qualify if specific rules are followed.

Using an LLC adds similar complications. An LLC with a single individual member taxed as a disregarded entity can be a shareholder in an S corporation.  Otherwise, it cannot.

Talk to a tax professional before using any entity to invest.

Consider How the Funds Are Used

Your money might be used to pay startup costs, hire staff, buy equipment, or build inventory. It might also be used for personal expenses if your child isn’t earning enough.

From a tax standpoint, how the funds are used can affect deductibility, basis, and potential repayment.

If you’re making a loan, and the money is used for deductible business expenses, your child may be able to write off those costs. If you are investing, the contribution becomes part of your basis, which can help reduce taxable gain on future sale.

If your child uses the funds for personal living expenses, those are not deductible, and you may be unable to recover your investment if the business fails.

Ensure your child has a clear budget and that your money is used according to your expectations.

Plan For What Happens Next

Before you invest, ask yourself: what happens if the business succeeds? What happens if it fails?

If the business grows, will you receive dividends or distributions? Will your ownership dilute if more capital is raised? Do you have voting rights or a say in future decisions?

If the business fails, will your child feel obligated to repay you? Will that create tension? Will you write it off as a loss? Will the IRS allow a deduction?

Also consider your own needs. Don’t invest money you might need for retirement, healthcare, or other obligations. Be honest about your financial capacity and your willingness to take risks.

Coordinate With Your Estate Plan

Investing in a child’s business may shift the balance of your estate. One child may receive significant support while others do not. That can cause resentment later.

If you want to equalize things, consider updating your estate plan to reflect the gift, loan, or investment. You might reduce another child’s inheritance, give equal gifts to other children, or include terms explaining your intentions.

If the investment is successful, you may need to plan for eventual estate tax exposure. You may want to move the ownership into a trust early, while the valuation is still low. That could reduce future estate taxes and simplify family transitions.

Get Professional Help

Helping your child launch a business can be deeply rewarding. It can also be complicated. A CPA, estate attorney, or financial advisor can help you avoid costly mistakes and structure the arrangement to protect everyone involved.

Before you write the check, consider all the implications. Get tax advice. Review the legal documents. Have tough conversations.

Done thoughtfully, investing in your child’s business can be a smart, strategic move. It’s not just an act of generosity. It’s a decision that can shape your legacy.

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