Did you know that family businesses create 78 percent of new U.S. jobs and employ 60 percent of our national workforce? Family businesses are an essential part of our economy, and a family business can be a special thing — in more ways than one.
When it comes to taxes, family businesses have some unique considerations. While most of the differences are benefits for the family business owner, the extra rules can seem confusing. And if you make a mistake, you could end up facing fees, penalties, or even a tax audit. In this blog article, we’ll try to help by answering some of the most common questions about tax treatments and employment tax rules for family business owners.
Do Federal Laws Treat Family Members Differently From Other Employees?
The answer is, it depends. In general, you should still treat your family members as employees and follow all employment laws and regulations (like OSHA rules) when dealing with them.
There are three relationships where things can function a bit differently tax-wise: your spouse, your parents, and your children. Outside of those immediate family relationships, you don’t need to make any special tax considerations if you hire a family member. So, if you hire your cousin, your niece, your brother-in-law, or even your brother, you can and should treat them the same as you would any other employee, including for tax purposes.
We’ll go over the unique situations that can come up when you hire a spouse, child, or parent throughout the rest of this article.
What Do I Need to Know if I Hire My Spouse?
If you hire your spouse strictly as an employee, then you’ve created an employer-employee relationship, and you should treat your spouse the same as other employees. However, if you and your spouse own the business together and share the profits and losses, then you’re most likely considered business partners, even if you don’t have a formal partnership agreement in place. If this is how your business works, you need to report any income or losses from the business on Form 1065.
What you should not do if you both own the business is try to treat the company as a sole proprietorship and report the income on a Schedule C (Form 1040). However, if you don’t want to treat the business as a partnership, you have an option. In that case, you need to make a qualified joint venture election.
How Do My Spouse and I Elect to Be Treated as a Qualified Joint Venture?
The IRS defines a qualified joint venture as a trade or business where:
- The only members are a married couple who file a joint return;
- Both spouses participate in the trade or business; and
- Both spouses elect not to be treated as a partnership.
If you have a limited partnership or a limited liability company (LLC), you aren’t eligible for the qualified joint venture election. To make the election, each spouse must report their share of profits and losses by attaching a completed Schedule C form to their individual income tax return.
What Do I Need to Know if I Hire My Child?
Hiring your kids could potentially lead to some headaches, but tax issues shouldn’t be among them. The IRS rules for hiring your children who are under 21 provide some tax benefits that can help your business’ bottom line.
If your child is under 18, then you don’t have to pay either of the following types of taxes on their wages:
- Medical and Social Security taxes, also known as FICA (Federal Insurance Contributions Act) taxes
- Unemployment insurance taxes, also known as FUTA (Federal Unemployment Tax Act) taxes
Also, you can deduct the salary or wages for your child from your taxes as a business expense. If your child is over 18, but under 21, then you have to pay Medical and Social Security taxes on their wages, but not unemployment taxes.
With the tax advantages of hiring a child come some responsibilities. You need to treat your child like a real employee, which means paying them a competitive wage for their work and complying with all laws and regulations.
Keep in mind that you need to withhold federal employment taxes from your child’s wages once they turn 18, or at any age if your business is a corporation or a partnership where at least one partner isn’t the child’s parent.
However, if your child is only working part-time, they may not end up owing any taxes at all. Under the Tax Cuts and Jobs Act, your child can receive the new standard deduction, which allows them to avoid paying federal income taxes on their first $12,000 of wages each year.
What Do I Need to Know if I Hire My Parent?
Taking on mom or dad as an employee is pretty simple from a tax standpoint. You’ll need to pay Social Security and Medicare taxes on your parent’s wages and make the appropriate withholdings, but you don’t have to pay unemployment taxes.
Once you understand the tax implications of hiring a parent, you’ve only got one challenge left: trying to convince your mom or dad that you’re in charge. Good luck.
How Do I Make Sure I’m Withholding the Right Amount From My Family Members’ Paychecks?
Family members should complete Form W-4 so you can get the correct withholding amount for federal income tax. You can also use the IRS’ Tax Withholding Estimator to double-check that you’re withholding the right amount.
Should I Hire My Family Members for the Tax Benefits?
Only you know your family, so we can’t answer this question for you. As a general rule, the tax savings for employing a family member are nice perks, but they won’t create game-changing savings for your business. So, you should probably only hire a family member if they’re the right person for the job.
Contact S.H. Block Services for Help with Your Family Business Tax Deductions and Returns
If you need help reducing your family business’ tax bill, please contact S.H. Block Tax Services today to speak with one of our skilled and experienced tax attorneys. Our attorneys and support staff have years of experience helping small business owners identify helpful and lucrative tax credits and deductions. We also have certified and trustworthy bookkeepers who can help you keep accurate and detailed records all year long.
Score. (2018, March 14). Family-Owned Businesses Create 78% of New U.S. Jobs and Employ 60% of the Workforce [press release]. Retrieved from https://www.prnewswire.com/news-releases/family-owned-businesses-create-78-of-new-us-jobs-and-employ-60-of-the-workforce-300613665.html
The content provided here is for informational purposes only and should not be construed as legal advice on any subject.