From saving for retirement to lowering the family’s total tax bill, hiring family members can seem like an attractive option for many taxpayers. But there can be important considerations, such as employee/contractor classifications, payroll and other miscellaneous taxes.
“According to the IRS, hiring family members is one of many advantages of owning and operating your own business,” said Kris Yamano, partner at Crewe Advisors in Scottsdale, Ariz. “If done correctly, hiring a spouse, parent, sibling or child can enable a family to increase retirement savings and potentially reduce overall tax liability.”
“Putting a family member on payroll can turn high-taxed income into tax-free or low-taxed income, and you can even make retirement plan contributions for your child,” said Gail Rosen, a CPA in Martinsville, N.J. “You can also save self-employment tax dollars by shifting your earnings to a child; services provided by a child under age 18 while employed by a parent aren’t considered employment for FICA tax purposes.”
Actual tax savings depend on the relationship and age of the person employed and the structure of the business/ownership, said Kathleen Stewart, a senior wealth strategist at BNY Mellon Wealth Management. Classification of employee versus independent contractor is also important.
Statistics vary, but most experts agree that family-owned or -controlled operations constitute a large part of the nation’s business base. Passing the baton in these businesses has created misconceptions through the years—often blanket ones about tax benefits.
“The income tax benefit is nominal and not necessarily a reason to hire a family member,” said Gerry Clancy, a CPA and partner at Armanino LLP in San Ramon, Calif. “You might gain some tax rate relief in getting an ordinary wage deduction at the owner level higher tax rate than the ordinary income tax rate at the child level. The main benefit for employing family members would be to generate earned income and provide for the retirement savings potential, especially for younger [or] teenage children.”
Some of the biggest misconceptions include that you can even hire a family member in the first place. “You just need to ensure that they’re a bona fide employee—that is, they add value to the business for a reasonable wage,” Yamano said.
She added that not all family members are equal when it comes to working in the family business: Spouses and children may be treated differently from a tax perspective, and children of different ages may also be treated differently from one another.
Clancy said there are a few payroll tax implications for hiring family members:
• Employ your spouse: If one spouse controls the business and directs the other, then it’s a simple employee/employer relationship and there are no payroll tax benefits; wages will be subject to all taxes.
• Employ your child: Younger than 18 is not subject to FICA or FUTA taxes; 18 to 21 is subject to FICA but not FUTA. Both taxes apply to those older than 21.
• Employ your parent: Those wages are not subject to FUTA tax.
FUTA (unemployment) tax exempts earnings paid to a child under age 21 while employed by their parent who files as a sole proprietor, single member LLC or as a partnership owned solely by the parents, Rosen added.