Approximately 90% of small businesses are either family-owned or run by family members. If your business falls into the majority, you’ve likely hired a few (or more than a few) family members to work at your company.
If you employ relatives, you need to make sure you’re staying legally compliant and taxing them correctly. Otherwise, you could wind up with some penalties and tax issues down the road. Read on to learn about family taxation and how to remain legally compliant when taxing your family members.
What is family taxation?
There are no laws against hiring family members in small business. However, hiring family members does present unique tax and employment situations.
In the business world, family taxation means the taxes you withhold from family members’ wages. Like you would with regular employees, you need to withhold taxes from family members’ wages.
The type of tax and whether or not you can tax a relative depends on a few different factors, including the member’s relationship to you, their age, and your type of business structure.
You might need to withhold and/or contribute some of the following taxes when you employ a family member:
- Social Security tax
- Medicare tax
- Federal Unemployment Tax Act (FUTA) tax
- Federal and state income tax withholding (if applicable)
- Multiple pay rates
- Unlimited payrolls
- Free employee portal
- Time and attendance integration
Family taxation scenarios
Now that you have a little background information on family taxation, let’s take a look at a few scenarios. Three of the most common examples of when you would need to tax family members include when you:
- Employ your child
- Employ your spouse
- Employ your parent
So, how does family taxation work in these above scenarios? Let’s find out.
1. Child employed by parents
When you employ one of your children, the way you tax their wages depends on their age.
If your child is under the age of 18, you don’t need to withhold Social Security or Medicare taxes if your business is a sole proprietorship or partnership with your spouse.
You do not have to pay FUTA tax if your child is under the age of 21. Children who are at least 18 are subject to paying FICA tax (aka Social Security and Medicare taxes).
You must withhold income tax, regardless of your child’s age.
A child’s wages are subject to Social Security, Medicare, and FUTA taxes if they work for a(n):
- Corporation
- Partnership (if at least one partner is not a parent)
- Estate
Before hiring your child (or any child), make sure to brush up on child labor laws. Review both federal and state child labor laws to ensure you’re compliant.
Child labor laws can vary from state to state. Child labor laws restrict things like the number of hours a child can work, time of day, and types of work.
| Age | Taxes Wages are Subject to |
|---|---|
| Under 18 years old | Income taxes, but no FICA or FUTA taxes |
| 18 – 21 years old | Income and FICA taxes No FUTA taxes |
| 21+ years old | Income and FICA taxes FUTA taxes under certain circumstances* |
*Pay FUTA tax when a child is over 21 and works for a corporation, partnership, or an estate.
2. One spouse employed by another
If you employ your spouse, their wages are subject to income tax withholding, Social Security, and Medicare taxes.
You must pay FUTA tax if the business is a corporation or partnership (even if the spouse is a partner).
For more information about married couples in business, check out the IRS’s website and refer to Publication 15, Circular E, Employer Tax Guide.
3. Parent employed by a child
Say the shoe is on the other foot and you employ your parent. Your parent’s wages are subject to income tax withholding and FICA taxes. However, wages paid to a parent are not subject to FUTA tax, regardless of the job type.
Don’t withhold FICA tax from your parent’s wages for work not performed at your business. FICA tax only applies to domestic services if all of the following are true:
- You employ your parent
- You have a child or stepchild living in the home
- You’re a widow or widower, divorced, or living with a spouse with a mental or physical condition preventing them from taking care of a child or stepchild for at least four continuous weeks in a quarter
- The child or stepchild is either under 18 or requires personal care of an adult for at least four continuous weeks in a calendar quarter due to a mental or physical condition
| Tax Type | Child Employed by Parent | Spouse Employed by Spouse | Parent Employed by Child |
|---|---|---|---|
| Income Tax Withholding | Yes | Yes | Yes |
| FICA Tax | No (if under 18) Yes (if over 18) | Yes | Yes |
| FUTA Tax | No* (Pay FUTA when a child is over 21 and works for a corporation, partnership, or estate) | No | No |
Steps for hiring family members
If you opt to hire family members, make sure you treat them like any other employee. This means you need to collect new hire paperwork, add them to payroll, and track their hours (if applicable).
When hiring a family member, you might decide to skip the interview and background screening processes altogether because you already know the individual.
Although you can skip over a few steps, there are a few things you must still gather from family members when you hire them. This includes things like:
- Form W-4
- State W-4 form (if applicable)
- Form I-9
After collecting paperwork from them, you need to add your family member to payroll. If you plan on offering them direct deposit, get their bank account information so that you can deposit their net income into their bank account.
When you run payroll for your family members, withhold the correct taxes from their gross pay. If you require employees to submit timesheets or use time and attendance software, be sure to gather time and attendance records before running payroll.
Like with any other employee, be sure to provide each family member employee with a pay stub that lists their gross pay, taxes withheld, deductions, and net pay.
Pros and cons of hiring family members
Before you recruit one of your relatives to work for you, weigh the pros and cons of hiring family members. If things don’t work out, it could hurt your venture’s success. And even worse, it can ruin your relationship with your relative.
Take a look at a few advantages and disadvantages of hiring family below.
Pros:
- You know who you’re hiring
- You’re aware of a relative’s strengths and weaknesses
- The relative may work for lower rates (e.g., minimum wage)
Cons:
- Nepotism in the workplace
- Family member might not be qualified
- Ruin both the personal and business relationship
Ready to make your payroll process a breeze? Patriot’s Full Service payroll has free setup and expert support. We also file and deposit federal, state, and local taxes. And, to top it all off? Our accuracy is guaranteed. Try us for free today!
This article has been updated from its original publication date of November 20, 2019.
This is not intended as legal advice; for more information, please click here.
