Family members can be great for business. There are a number of positive results when a business relies on kinship: financial benefits, tax benefits and the growth of the business. But one needs to consider proper planning when involving family in business affairs. One positive impact in family businesses is the wealth of knowledge, skills and characters that will be passed on to the next generation. Early on, the little ones will learn about hard work, internalize the value of money—and realize its importance, which results in lessons about earning, saving and properly spending money.
Tax requirements when hiring members of family
Starting your own business also means you have the advantage of hiring members of your family. Tax requirements, though, will vary when the business employs family members compared to regular employees. Here is a bunch of information that could help distinguish the differences.
Child employed by parents
For a sole proprietorship, parents can hire their children, who are under 18 years old, to work in the business and they will not be required to pay social security and Medicare taxes. The same rule follows for a business under the partnership principle as long as each partner is the parent of the child.
Refer to the “Covered services of a child” below
Payments for children under the age of 21 who are working for their parents will not be imposed with a Federal Unemployment Tax Act (FUTA) tax. But regardless of age, salaries of children are subject to income tax withholding.
Covered services of a child
There are various situations where a child’s salary is imposed with income tax withholding, social security, Medicare and FUTA taxes. The situations include when the child works for a corporation even when his or her parent controls it; a partnership even if the child’s parent is a partner—unless both parents of the child are partners; and an estate, even if such belonged to a deceased parent.
One spouse employed by another
A person who works for his or her spouse in a trade or business will be imposed with income tax withholding, social security and Medicare taxes, but not the FUTA tax. Check out Husband and Wife Business.
Covered services of a spouse
When an individual works for a corporation, even when it is controlled by his or her spouse, his or her salary will still be subject to income tax withholding, social security, Medicare and FUTA taxes. The same goes for individuals who work in a partnership, even when the spouse is a partner.
Parent employed by child
Parents who work for their children in a trade or business are still imposed with income tax withholding, social security and Medicare taxes. A parent employed by a child is exempted from FUTA tax regardless of the type of service.
Husband and Wife Business
Getting family members to work in one’s business is one of the better advantages of starting a company. Just take note that employment tax requirements for family members employed differ from regular employees. Here are some issues to tackle when starting a husband and wife business.
A spouse is only acknowledged as an employee if there is an employer-employee relationship. This is when one spouse has business control over the company—makes and implements decisions, while the other spouse takes orders or directives from the former. In this case, the second spouse is an employee, therefore, subject to income tax and FICA (social security and Medicare) withholding. In the case where the second spouse has the same power over the business—equal say in decision-making, equal service, while contributing capital, then the business is called a partnership. In this case, the company’s income should be indicated in the Form 1065, U.S. Return of Partnership Income.
Both spouses carrying on the trade or business
The Small Business and Work Opportunity Tax Act of 2007 was enacted on May 25, 2007. This law has affected how qualified joint ventures of married couples not treated as partnerships are viewed. Beginning January 1, 2007, the law’s provisions became effective. It basically allows husband and wife to file a joint return—not to be treated as a partnership—for Federal Tax purposes on a qualified joint venture granting that the only members of the venture are the husband and the wife. A qualified joint venture is defined as a business operation between two or more people, with this set of qualifications: 1) husband and wife are the only members of the joint venture, 2) both have significant roles in the trade or business, and 3) the spouses have chosen to apply the provision.
In order to maximize the advantage of hiring family members, here are some interesting schemes you can employ during the planning of business tax opportunities.
Not Withholding. A Simple and Easy Strategy
One thing business owners—who are also parents of employees under 18 years old—should realize is that there is no requirement to withhold payroll taxes when paying children who work in the business. Among the dreaded required taxes are: Federal Unemployment Tax Act (FUTA), State Unemployment Tax Act (SUTA), and Federal Insurance Contributions Act (FICA). These are thorns for every business owners who have to match the same for their employees. However, almost every state allows the business owners to waive the children out of the Workers’ Compensation coverage because they are covered under the family medical plan.
But this provision that allows the business owner a way out of withholding payroll taxes from children below 18 years old is only applicable to businesses that are Sole Proprietorship or Limited Liability Company that is owned by the mother and father under the partnership type of business. However, those with an S- or C-Corporation will not be exempted from payroll taxes. If children are employed under a corporation, they will be taxed like regular employees through the payroll withholding system.
There is still a way to avoid the withholding problem in an S- or C-Corporation: the children can be paid through a family management company LLC. But such should be established as a Sole Proprietorship disregarded LLC owned by the father and mother to support the operations of a corporation; then the family management company is then paid a management fee by the Corporation. This is a wise plan widely practiced by the wealthy, while also taking advantage of the opportunity to hire the children to provide services to the company.
Your Children Shouldn’t Pay Taxes Either
Everybody—including children—doesn’t need to pay federal taxes on the first $6,300 of the year’s salary. There’s a great scheme coming called Standard Deduction. Regular employees will take this amount—tax-free—home with them. But when you hire your child, the amount stays in the family. Plus, the child can still be declared in the tax return as a dependent. So you take the exemption and a Child Tax Credit.
Keep it Legal
You have to keep in mind that these strategies are not meant to be fraudulent. There must be a real reason why you have to hire your child to be an employee. The children should be authentically employed to work, serve or make transactions. The Internal Revenue Service conducts an audit. So one should be prepared to produce a report on work rendered and the salary paid, which should be appropriate to the work or service supplied. One should also take into consideration that the kind of work rendered by the child should be appropriate for his or her age. And to reiterate, you simply cannot employ your child on paper so he or she can render household chores and be paid for it.
The rules have been laid out, the strategies have been discussed. Now here are a number of reasons why the wealthy love to employ their children for employment opportunities.
Take It To the Next Level. Create a Retirement and College Savings Account
With the children having earned their own money, they can already contribute to the Roth or Standard IRA. These contributions have been proven to be very useful especially when pulled out later for college expenses. Meanwhile, as the child continues to work, contributions to the Roth IRA also continues to balloon. Such contribution can help every child start his or her retirement fund or college savings fund.
One should be mindful about paying taxes at higher rates. One should also look at the possibility of adding to a child’s college fund. Treat children as regular employees by giving them their payroll, which in time can be used for college education. Just follow the procedures indicated and do what wealthy business owners usually do, which is maximize the benefits of having family members at work. Using these strategies has helped people save thousands of dollars while changing the lives of the family through bonding and words of wisdom.