One of the advantages of owning and operating your own business is the ability to hire family members to fill open positions. This can be a significant perk in today’s tight labor market. Bringing on family members can also have tax benefits for all involved and offers an opportunity to start retirement savings accounts for your children. The potential benefits vary based on such factors as the familial relationship, your children’s ages, and the type of entity you chose for your business. Here’s what you need to know.
Hiring Your Spouse
When your spouse works for your business, their wages are subject to income tax withholding and Social Security and Medicare taxes (more commonly known as FICA taxes) but not Federal Unemployment Tax Act (FUTA) taxes. Employers must generally pay 6.0% of an employee’s first $7,000 earnings as the FUTA tax, subject to tax credits for state unemployment taxes. That means you save the money you’d otherwise spend for a non-spouse employee’s FUTA. However, your spouse must be compensated as an employee; the wages must be reported on Form W-2. When spouses carry on a business together and share in the profits and losses, the IRS may deem them partners (even without a formal partnership agreement).
Employing Other Family Members
Children who work for their parents’ businesses are subject to income tax withholding regardless of age. If the business is a corporation or partnership, children’s wages are also subject to FICA taxes and FUTA taxes unless each partner is a child’s parent. But substantial savings are possible for a business that’s a sole proprietorship or a partnership in which each partner is a parent of the child-employee, depending on the child’s age.
Children under age 18 aren’t subject to FICA or FUTA taxes. When FICA taxes apply, the employer and the employee must pay 7.65% of the employee’s earnings (subject to annual limits). Avoiding FICA means more money in your and your child’s pockets.
Children 18 to 20 years old aren’t subject to FUTA taxes. But they’re subject to FICA taxes.
It’s worth noting that children generally are taxed at lower rates than their parents. Moreover, a child’s income can wholly or partially offset the child’s standard deduction. If your child earns less than the standard deduction amount, it’s tax-free and is deductible for the business.
In addition, your child’s earned income can be contributed to an IRA, with the potential for impressive compounding over time. As earned income, this money also isn’t subject to the so-called “kiddie tax.”
There are benefits to be had from hiring your children who are 21 or older. A sole proprietor parent can provide up to $5,250 in annual educational assistance, tax-free, to an employee who is:
- A legitimate employee of the business,
- Not more than a direct 5% owner of the business, and
- Not a dependent of the sole proprietor.
Parents can deduct the cost of educational assistance, cutting their self-employment and income tax liability. Educational assistance payments also aren’t subject to FICA or FUTA taxes. What about hiring your parents? The wages of parent-employees are subject to income tax withholding and FICA taxes. You don’t have to pay FUTA taxes, however.
For tax purposes, family members must be bona fide employees who perform age-appropriate work that needs to be done. They also must be paid a reasonable, non-excessive amount for the work performed. Of course, you also want your family members to be qualified for your reasons. Tax breaks are rarely worth putting the wrong person in the wrong job.
Employing unqualified or overpaid family members also risks alienating employees who aren’t family members. You can damage their morale if the family is seen as receiving favorable treatment. Consider placing young family members on lower rungs of the “ladder” and teaching them the basics rather than putting them in positions they’re not ready for yet.
It would help if you also considered the implications for familial relationships, including those with relatives who aren’t hired. Working together can lead to stress, and resentment can fester in even the closest families.
If you decide to hire family members, you must dot your i’s and cross your t’s. For example, keep thorough records, including timesheets and formal job descriptions. Timely file the necessary payroll tax returns, conduct regular performance appraisals and check any applicable state laws. Above all, contact your R+R tax advisor and legal advisors to ensure you’ve covered all the bases.
Reynolds + Rowella is a regional accounting and consulting firm known for a team approach to financial problem solving. As Certified Public Accountants, our partners foster a personal touch with our clients. As members of DFK International/USA, an association of accountants and advisors, our professional network is international, yet many of our clients have known us for years through the local communities we serve.
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