Family members can be integral to the success of a small business. In fact, small business owners hiring spouses and children is fairly common. However, there are certain tax implications that go hand-in-hand with hiring. The most important thing to know is those small business owners are still required to follow the law regardless of whom they hire.
By the time a small business is ready to hire, it is also ready for professional accounting and/or payroll. Dallas-based BenefitMall advises small business owners to have some good discussions with an accountant before making that first hire. An accountant is the most qualified individual to explain all the tax considerations.
With all that said, let us take a look at some of the basic rules governing small business owners who hire family members. Remember that a small business can be operated as a sole proprietorship, partnership, or corporation.
Hiring a Spouse
Hiring a spouse is probably the most common form of employing family members. The tax implications of doing so start with determining how a business is organized. For sole proprietors, things are fairly straightforward.
Assuming that the couple has a joint bank account into which all business proceeds flow, taxation is relatively simple. As sole proprietors, all business income is considered personal income with no regard for how it was produced. If the couple files jointly, they jointly pay all income and self-employment taxes. Self-employment tax covers FICA. Sole proprietors do not pay FUTA.
If the couple files separately, records must be kept of how much the spouse actually earns. Taxes would be withheld from the spouse’s paycheck and paid along with the company’s share. For partnerships and corporations, taxes are treated the same way. The spouse receives a weekly paycheck from which income tax, FICA, and FUTA are all withheld.
Hiring a Child or Parent
Things are a little less straightforward when small businesses hire children or parents. Children under the age of 18 must pay income tax on their earnings. They do not pay FICA or FUTA. FICA kicks in only when the child turns 18. As for FUTA, that depends on certain circumstances that may or may not be applicable. For example, a child over the age of 21 pays FUTA if the employer is organized as a corporation, partnership, or estate.
Moving on to parents, taxes are paid in a similar fashion. Parental pay is subject to both income and FICA tax withholding. Parents do not pay FUTA. Also, note that there is an exemption for FICA when parents are employed: it is not collected on domestic work – at least under most circumstances. It is only collected on work done for the child’s business.
There is one exception to this exemption. If a parent is hired to provide supervised care for another family member, FICA should be withheld from their parent’s paycheck provided all three of the following conditions are true:
- There must be at least one child or stepchild living in the home.
- The employer must be a widow, widowed, divorced, or living with a spouse not physically or mentally capable of caring for a dependent child or stepchild for at least four consecutive weeks.
- The child or stepchild being cared for is either under 18 or, due to a physical or mental condition, requires personal care for at least four continuous weeks.
As you can see, there are quite a few tax implications that come with hiring family members to work in a small business. Again, accountants and payroll professionals should be consulted whenever there are questions.