Employing Family Members and Tax Implications - Rosenberg Chesnov (2024)

The short answer is: Yes, absolutely.

However, there are some important considerations to keep in mind. Many of the potential challenges are not tax-related but interpersonal.

For example, favoring family members in certain roles can foment resentment among other members of your team, and communication issues can quickly arise. Just like any other employee, it’s essential that family members possess the skills and qualifications necessary for the roles they will be taking on and that they be compensated fairly for their work based on their skills and the responsibilities they have. Transparency and professionalism are also critical to avoid conflict.

For our purposes in this blog post, however, we’ll focus more specifically on the legal and tax implications.

Remember that laws and regulations vary by country and jurisdiction, so it’s advisable to consult with legal and financial professionals who are familiar with your location.

Below are some general legal considerations:

• Anti-Discrimination Laws:When hiring a family member, you must ensure you’re not discriminating against other potential candidates based on their familial status. It’s essential to treat all applicants fairly and equally.
• Fair Compensation and Working Conditions:Like any other employee, you should provide fair wages and suitable working conditions for your family member. Their compensation and benefits should be in line with industry standards and local labor laws.
• Employment Contract:It’s wise to have a written employment contract detailing the terms of employment, such as job responsibilities, compensation, work hours, and any other relevant information. This can help prevent misunderstandings in the future.
• Conflict of Interest:If your family member is involved in decisions that could be perceived as favoritism or if their involvement could potentially harm the business’s interests, you should take steps to mitigate conflicts of interest and ensure transparency.

Here are some general tax considerations:

• Payroll Taxes:You will likely need to withhold payroll taxes (such as income tax, Social Security, and Medicare) from your family member’s wages, just as you would for any other employee. Both you and your family member would be responsible for paying these taxes.
• Employee Benefits:If you provide benefits like health insurance or retirement plans to your family member, these may have tax implications for you and the family member. Consult with a tax professional to understand the tax treatment of such benefits.
• Gift Tax Considerations:Depending on the jurisdiction, there might be gift tax implications if you provide your family member with significantly higher compensation than the fair market value for the work performed. This could be seen as a way to transfer wealth and avoid taxes.
• Deductibility of Expenses:Business expenses related to employing your family members, such as their wages, can be deducted from your business’s taxable income. However, the expenses must be reasonable and consistent with the market rates for the type of work performed.
• Self-Employment Tax:If your family member is classified as an independent contractor rather than an employee, they might be responsible for paying self-employment taxes. This can have different tax implications compared to being an employee.

Once again, the simple answer is: Yes, of course. However, once again, there are some things to keep in mind.

When your business compensates a family member, you must collect aW-4 formfrom them upon hiring and deduct federal income taxes according to the information they provide. You will also need to withhold FICA taxes and factor in their pay when calculating the FICA taxes owed by your business.

You should also be sure to account for family member compensation when determining unemployment taxes and worker’s compensation and treat overtime payment for family members like you would for other staff. (This rule applies to family members who are exempt and earn below the overtime threshold.)

If your business offers holiday or sick pay and grants paid vacations to employees, extend the same benefits to family members. Additionally, if a family member is eligible for other perks like your company’s health plan, they should be included in that employee group.

Essentially, all benefits given to regular employees should also be provided to family members employed within your company.

There are some significant potential tax advantages to hiring family members.

For example, when a parent who operates a sole proprietorship or an unincorporated business employs their child below 18, neither the child nor the business is subject to FICA (Federal Insurance Contributions) taxes.

Wages paid to your child aged 18 to 20 are subject to FICA taxes but not FUTA (Federal Unemployment) taxes. As for children over 21, your company must treat them as ordinary employees for payroll tax and tax withholding purposes.

Furthermore, payments to children as wages can lower the business’s net income, consequently decreasing the self-employment taxes the parent must pay.

Finally, the income earned by the child is often taxed at a lower rate than the parent’s income, and a child’s income can be offset partially or entirely by their standard deduction. If your child earns less than the standard deduction, their income will be tax-free and deductible for the business.

There may also be benefits to hiring your spouse or parent — for both, their wages are typically not subject to FUTA taxes.

All of that being said, if you are considering adding a family member to your business’s payroll, be aware that the IRS will closely scrutinize your business, and any errors you’ve made could lead to an audit.

Another critical point:Remember that employing your child in the family business is still child labor, and you must adhere to all relevant laws. No special leniency is granted to parents who involve their children in the family business.

As always, attempting to exploit tax benefits without accurate records can also raise issues…so keep track of everything!

What are the withholding, reporting, and payment requirements?

Finally, ensure you are aware of all specific tax treatments and rules that may apply in your situation.

Here are some first steps:

• As mentioned above, have each family member you hire complete a Form W-4 and withhold the appropriate amount of federal income tax from their wages.
• If you don’t already have one, you should also obtain an EIN (Employer Identification Number) for your business. This is necessary for tax reporting and withholding purposes.
• Make sure you withhold the correct share of Social Security and Medicare taxes and pay the employer’s share.
• Maintain accurate records of hours worked, wages paid, and any benefits provided for each family member employee. Provide your family members with regular pay stubs.
• File quarterly reports usingForm 941, the Employer’s Quarterly Federal Tax Return.
• At the end of the year, provide each family member employee with a Form W-2, Wage and Tax Statement. This form outlines their annual wages and the taxes withheld. You must also submit Copy A of all W-2 forms and Form W-3 to the Social Security Administration.

It’s important to emphasize that treating family members as legitimate employees is critical to compliance. Properly documenting their work, responsibilities, and compensations will help you navigate any potential audit or inquiry from tax authorities.

Since tax regulations and reporting requirements can vary based on your location and specific circ*mstances, it’s an excellent idea to consult with tax professionals (like us!) who can provide tailored guidance and ensure you’re fulfilling all your legal obligations.

If you are a client and would like to book a consultation, call us at +1 (212) 382-3939 orcontact us hereto set up a time.

If you aren’t a client, why not? We can take care of your accounting, bookkeeping, tax, and CFO needs so that you don’t have to worry about any of them. Interested?Contact us hereto set up a no-obligation consultation.