Many businesses in America are family-run, that is, the entire business is owned and operated by a single family with few or no employees being recruited from outside. While employing family members to run your business can offer many benefits, have you considered the tax implications of such a move?
Tax Rules to Consider When Employing Family
You can employ your family members in your business as a tax-saving strategy. However, you should ensure they are bona fide employees to avail of the associated tax deductions. Additionally, you need to comply with IRS rules in this regard.
1. Legal standing of your relatives
The rules regarding employing family members differ based on family relationships and employee age. For instance, your spouse will be treated differently under the rules from your children as your employee. Your spouse, as your employee, is not required to pay taxes under the Federal Unemployment Tax Act (FUTA).
Besides, children as employees are also treated differently based on their age and business structure. Children who have yet to cross 18 do not have to pay Medicare, Social Security, or FUTA taxes on their earnings from the business if their parents run a sole proprietorship or partnership in which both parents are partners. Children aged between 18 and 20 are treated like spouses under the IRS rules and are only exempted from paying FUTA tax.
2. Avoid the Kiddie Tax (FICA Tax) and other benefits
By employing your children who are below 18 years of age in your establishment, you can avoid paying the Federal Insurance Contributions Act (FICA) Tax which is deducted from your employees' paychecks. This means you are not required the mandatory FICA amounts from your children's paychecks.
Besides, if your child earns less than the standard deduction amount, he/she is not required to pay federal taxes.
3. Assign age-appropriate and legitimate work
Ensure you assign work that is appropriate for your children's age. For instance, you cannot state that a young child operates heavy machinery for your business. Never attempt to hoodwink the system using fake payroll schemes involving relatives. Your relatives must work for you and be reasonably compensated based on the work done. You cannot pay them above the normal wage rates paid to the rest of your employees.
4. Begin saving for the future early
You can encourage your child to begin saving early by investing his/her earned income from the business in an individual retirement account. Your child will benefit substantially from the compounding effect of commencing a retirement fund at such a young age.
5. Deductions to reduce overall tax liability
When you legitimately employ a family member in your business, you can claim the wages, medical, and other benefits paid as a business expense deduction under Schedule C or Schedule F. This reduces your self-employment tax liability. As a sole proprietor, you can also contribute an amount not exceeding $5,250 as annual tax-free education assistance to each eligible family employee and deduct the same as business expenses.
Employing family members can provide several benefits, but it's crucial to understand and comply with the tax rules to avoid potential pitfalls. By familiarizing yourself with the specific tax treatments for different family relationships and maintaining proper documentation, you can ensure that your family-owned business remains compliant with IRS regulations.
Finlotax: Your Partner in Navigating the Complex Tax Laws in CA
At Finlotax, we excel at simplifying complex taxation regulations for our clients and offer tailored tax consultancy services in CA. Our expertise and range of services include CFO support, bookkeeping, tax preparation, tax planning, payroll management, and compliance solutions, which can help you maximize tax savings. To learn more about employing family members in your business and improving tax efficiency, contact us at 408-822-9406 and book your consultation today!