Employing Family Members

What is it?

If you own a business, hiring a family member as an employee may prove beneficial (from a tax standpoint). Specifically, you should consider the availability of business expense deductions and the possibility of income shifting.

Parents employing children

A parent-employer can deduct a child’s wages as a business expense if:

  • The child performs work in connection with the parent’s trade or business (or income-producing property)
  • The child actually renders services to the trade or business
  • Payments are actually made
  • The wages are reasonable for the services actually rendered by the child

The earnings of a child under age 18 who is employed by a parent owning a sole proprietorship or partnership are not subject to FICA (Social Security and Medicare taxes). Likewise, there is an exclusion from FUTA (unemployment tax) if the child is under age 21.

Employing adult family members

Your ability to take business deductions and shift income depends largely on the type of business entity you have. The owners of C corporations and S corporations can provide certain types of tax-free fringe benefits to their employees, while deducting the cost of these benefits. Reasonable salaries (or other compensation) may also be deducted by C corporations and S corporations as ordinary and necessary business expenses. Generally speaking, employers can also deduct benefit plan contributions as business expenses.

Sole proprietorships and partnerships follow different rules regarding fringe benefits. Note, also, that sole proprietor employers can deduct as a business expense amounts paid to an employee-spouse for medical coverage; these amounts are excluded from the employee-spouse’s income.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2017