Business Tax Insights: Leveraging Family Employment

Tax considerations when employing a spouse, child, or parent

One of the benefits of managing your own business is the ability to employ family members to reduce tax liability. If you’re leveraging this opportunity, it is important to note that the employment tax regulations for family members can differ significantly from those applicable to other employees. Below is an overview of the employment tax rules and considerations when employing family members.

Tax considerations when employing your spouse

Scenario 1

You are substantially in control of the management decisions of the business and your spouse is working under your direction.

In this situation, your spouse is considered an employee by the IRS and subject to income tax and Social Security and Medicare (FICA) withholding but is not included in federal unemployment tax (FUTA).

Note. Generally, employing a spouse doesn’t increase the total tax on a joint return but it does give each spouse credit for Social Security earnings purposes. However, the result may be different if either spouse exceeds the Social Security tax limitation.

Scenario 2

Your spouse has an equal say in the affairs of the business, provides substantially equal services to the business, and contributes capital to the business.

In this situation, if the business is not incorporated, the IRS views your business as a partnership and the business’s income should be reported on Form 1065, U.S. Return of Partnership Income.

Note. Spouses who qualify as and elect to be a qualified joint venture are treated as two sole proprietors and each must report one-half of the business’s income and deductions on Form 1040, Schedule C.

Tax considerations when employing your children

Tax rules for payments relating to your child’s employment depend on the child’s age and your business entity type.

If your business is a sole proprietorship or a marital partnership where you and your spouse are the child’s parents, then:

• Children are subject to income tax withholding regardless of age.
• Children under 18 years old are not subject to Social Security or Medicare withholding.
• After the child turns 18, your business would withhold income tax, Social Security, and Medicare taxes
• Payments to children under age 21 do not have to be reported for FUTA tax purposes.
• Your business would not need to include the child on its unemployment tax returns until the child turned 21.

Note. If the business is a corporation, a non-marital partnership, or an estate (even if it’s the parent’s estate), then payments for your child’s services are subject to income tax withholding, Social Security taxes, Medicare taxes, and FUTA taxes regardless of age.

Retirement Planning Insight: If you employ your child, the child can establish a ROTH IRA and contribute up to the amount of their earned income. This is a great way to give your child an early start on tax free retirement savings.

Tax considerations when employing your parents

You will need to take into consideration a different set of rules if your business employs your parents, depending on your business’s entity type and the services the parent is performing.

If your business is a sole proprietorship and your parent employee is performing services for your business, then:

• Payments for the parent’s services are subject to income tax withholding, Social Security taxes, and Medicare taxes.
• Payments for the parent’s services are not subject to FUTA tax regardless of the type of services provided.

If your business is a corporation (even if it’s controlled by you), a partnership (even if you are a partner), or an estate, then payments for the parent’s services are subject to income tax, Social Security tax, and Medicare tax and must be reported for FUTA purposes.

If the parent is working for you but not performing services for your business, then:

Generally, your payments to your parent for services are not subject to Social Security and Medicare taxes unless the services provided are domestic services and each of the following conditions apply:

• You employ your parent,
• You have a child or stepchild living in your home,
• You are a widow or widower, divorced, or living with a spouse, who because of a mental or physical condition, can’t care for the child or stepchild for at least four continuous weeks in a calendar quarter, and
• The child or stepchild is either under age 18 or requires the personal care of an adult for at least four continuous weeks in a calendar quarter due to a mental or physical condition.

Your payments to a parent for services are not subject to FUTA tax regardless of the type of services provided.

Record-keeping for Family Employees

It is important to ensure that record-keeping best practices (e.g., keeping time reports, filing payroll returns, and basing pay on work performed, not on a relationship to the employer) are followed. Proper documentation will enable you to prove the deduction(s), if the IRS elects to examine your wages paid to family members.

If you have questions on family member employee tax considerations for your business, consult your Keiter Opportunity Advisor.