Articles

Tax Tips and Traps when Putting Family Members of the Payroll by Joanie B. Stein, CPA


Posted on December 17, 2019 by Joanie Stein

It is not uncommon for entrepreneurs to go into business with family members or to employ close relatives to work in their companies. In fact, putting family members on your payroll can not only help them earn their own money and gain valuable work experience, but it can also provide business owners with some unique tax-saving benefits. Following are some tips to keep in mind when combining work and family.

Spouses

If you and your spouse carry on a business together and share equally in decision-making, profits and losses, you may be treated for tax purposes as a partnership, even if you do not have a formal partnership agreement. When the business has employees, either of the spouses, as sole proprietors, may report and pay employment taxes.

Alternatively, spouses working together may elect tax treatment as a qualified joint venture, for which all items of income, gain, loss, deduction and credit are divided between the spouses based on their respective interests in the business. While each spouse will need to report their share of profits and losses separately on Schedule C tax forms, both will receive credit for social security and Medicare coverage.

In contrast, when one spouse operates a trade or business and employs his or her husband or wife, the wages of the employee-spouse are subject to employment taxes, including income tax withholding and Social Security and Medicare taxes (FICA taxes). Unless the business is structured as a corporation or a partnership, the spouse’s wages can also avoid federal unemployment tax (FUTA tax).

Children

Wages parents pay to their children for performing services for their businesses are subject to income tax withholding, regardless of the children’s ages. These wages are also subject to Social Security, Medicare and FUTA taxes when the business making the payments is an estate or when it is structured as a corporation or a partnership, unless each partner is a parent of the child.

If the child is younger than age 18, wages are not subject to FICA taxes, as long as the business is a sole proprietorship or a partnership between the parents of the children. However, a parent-employer will need to report the child’s compensation on a Form W-2, Wage and Tax Statement. When the child is under age 21, payments from a parent-employer are subject to FICA taxes but mot FUTA tax.

Parents

The wages paid to a parent employed by his or her child in a trade or business are subject to income tax withholding and social security and Medicare taxes but not FUTA tax. However, if you pay a parent for services they perform outside your business, perhaps as caretaker for your children in your home, FICA taxes will not apply.

Despite the tax savings you may reap by hiring family members to work with you, tread carefully to ensure all of you comply with all tax reporting responsibilities. In addition, take the time to consider how a relative you intend to hire will contribute to your business and fit in with your succession plans. As wonderful as it might be to keep the business in the family for future generations, handing the reigns of your business to a relative will require a significant amount of time and training to ensure their success.

About the Author: Joanie B. Stein, CPA, is a senior manager with Berkowitz Pollack Brant’s Tax Services practice, where she works with individuals and closely held businesses to implement sound strategies that are intended to preserve wealth and improve tax-efficiency. She can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at info@bpbcpa.com.

 

Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.