For the most part, hiring a family member is like hiring anyone outside your family. You still need to treat them like an employee, and they are subject to many of the same rules and regulations that any other worker agrees to.
But when it comes to your taxes, things get a little more involved. The taxes you withhold and report are slightly different depending on the role they play, how your business is organized, and your relationship with them. (For example, hiring your husband or wife will alter your tax responsibilities; hiring your second cousin will not.)
If your family member or spouse is truly an employee or partner in the business—if they have real business responsibilities, and this isn’t just a paper transaction—then the IRS will view you and your business differently in the following ways:
Federal unemployment taxes
For the most part, regardless of who you hire and what kind of business you own, you’ll still need to continue to pay most employment taxes, even if that person is your spouse or child. Employment taxes include federal income tax withholding, and FICA (which includes Social Security taxes and Medicare taxes).
You may be exempt from paying the federal unemployment tax, or FUTA, on certain family members. This possible exemption is the primary way your tax burden is affected by hiring family. Currently, the FUTA rate is 6%. It’s applied to the first $7,000 a business pays to each employee as wages during the year.
When you employ your spouse
If you’re the owner of a sole proprietorship and you want to employ your husband or wife in your venture, their wages are subject to typical employment taxes, except for FUTA.
Additionally, sole proprietors can obtain tax savings in connection with health insurance premiums for their spouses. If the employee-spouse purchases health insurance in their name and extends coverage to their employer-spouse, it can be written off as fully deductible to the business as a fringe benefit. Talk to an accountant about the best way to structure this.
However, if you’re a small business owner and your business is a corporation (even if you control it) or a partnership (and your spouse isn’t the other partner), you’ll have to pay all employment taxes, including FUTA, if you hire your spouse.
When you partner with your spouse
If one spouse substantially controls the business and directs the other, that’s an employer-employee relationship. If both spouses have equal say in the business’s affairs, however, that’s considered a partnership like any other, and they’ll need to file Form 1065 come tax season.
But if both partners agree to it, a married couple can be considered a “qualified joint venture” by the federal government for tax purposes. In this case, the partners will have to file Schedule C tax forms separately, but both will receive credit for social security and Medicare coverage purposes.
When you employ your child
If your business is a sole proprietorship or a partnership with your spouse, payments for the services of your child if they’re under age 18 aren’t subject to any FICA or FUTA taxes. You may deduct their salaries as business expenses as well.
If your child is over 18 but under age 21, their pay is subject to FICA, but not FUTA.
The IRS is aware that this can result in substantial savings for businesses, so be sure to treat your child like a real employee, compensate them fairly, and comply with all legal requirements. Otherwise, you may lose these tax deductions.
Part of treating your child like a regular employee means withholding all federal employment taxes once they come of age. You’ll also have to pay these taxes, regardless of the child’s age, if your business is a corporation, partnership (if at least one partner is not a parent), or estate.
When you employ your parent
Let’s say the shoe is now on the other foot, and you’re employing one of your parents in your trade or business. Your parents’ wages are subject to income tax withholding and FICA taxes, but not FUTA tax. Keep in mind that Social Security and Medicare taxes do apply to payments made to your parent for “domestic services” in particular if all of the following things 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 4 continuous weeks in a calendar quarter; and
- The child or stepchild is either under age 18 or requires care for at least four continuous weeks per quarter due to a mental or physical condition.
The savings to your small business of hiring a child, spouse, or parent are significant, but likely not enough to affect whether they should be hired over someone more qualified. As always, do the right thing for your business. If that means hiring a family member – great. If not, look elsewhere for the skills needed to help you succeed.
The information in this article is up to date through tax year 2021 (taxes filed in 2022).
Eric Goldschein is a staff writer at Fundera, a marketplace for small business financial solutions. He covers entrepreneurship, small business trends, finance, and marketing.