Hiring Family Members is similar to hiring or employing any other individual. You will be required to comply with the same labor regulations and deduct the taxes. But there are some exceptions when you hire your spouse or children, and it depends on the organisation’s legal structure.
Legal Structure of Business
Before we discuss the tax implications, tax benefits, and best practices, you should understand your company’s legal structure as follows:
- Sole Proprietorship: No separate business entity from the owner. All business income, including family salaries, is reported on the owner’s personal tax return.
- Limited Liability Company (LLC): Offers flexibility in tax treatment and can be considered as a pass-through entity.,
- S Corporation: Separate legal entity from the owner and offers potential tax advantages but limitations on ownership structure.,
- C Corporation: A separate legal entity that is required to pay corporate income tax on profits. It offers more flexibility but has a higher tax burden.
It may be good for a business to hire family members, but this has different tax consequences in the United States. For an in-depth summary, see below:
Tax Implications of Hiring Family Member
The tax implications of hiring family members can vary depending on the legal structure of your business.
Federal and State Income Taxes:
Irrespective of whether you are a sole proprietorship, corporation, or partnership firm, Wages are considered as Income of the Employee, and hence, following compliances needs to be done
- Wages paid to family members are considered income.
- Withhold federal and state taxes from their paychecks.
- Use Form W-4 to determine withholding.
Social Security & Medicare Taxes:
These taxes will also need to be deducted from the employee’s pay.
Federal Unemployment Tax:
The provisions of the Federal Unemployment Tax Act (FUTA) vary depending on the types of entity.
- Sole Proprietors: FUTA provisions will not be applicable to hiring family members in your business so No FUTA on family members’ salaries.
- Partnerships/Corporations: FUTA applies.
Tax Benefits of Hiring a Family Member
Hiring a family member can indeed be advantageous for a business. Yet, there may be certain tax implications to consider in particular situations; however, these should be approached with prudence and solely after seeking guidance from a certified tax expert. Some key tax advantages are mentioned below:
- Shifting of Income to Lower Tax Bracket: Assigning a part of your business earnings as salaries to family members might decrease your taxable income, thereby moving your income to a lower tax bracket and thereby reducing your total tax obligation. The remuneration should align with the market rate for the services rendered, and any attempt to fraudulently increase income for tax benefits may be detected by the IRS, resulting in fines.
- Potential for Deductions for Employee Benefits: Employee benefits provided to family members, such as health insurance or retirement plans, may be deductible based on the firm structure and specific circumstances.
- Boost Retirement Savings: There are potential benefits to employing one’s spouse in terms of retirement planning. You and your spouse may each maintain a separate retirement account in which you make contributions. Tax-deductible employer contributions to retirement accounts have the potential to increase savings by twofold while concurrently decreasing tax obligations. For instance, you and your spouse may both participate in a 401(k) plan offered by your employer. You may defer to the plan a maximum of $23,000 in compensation in 2024 (or $30,500 if both are 50 or older), in addition to any company matching contributions.
Best Practices to Keep in Mind
Here are some things to keep in mind if you’ve decided to hire family member to work for your company. When dealing with IRS audits, having extra premiums on hand is always a good idea
Written Employment Agreement: Detail roles, compensation, and conditions.
- Create an employment agreement in writing that specifies duties, remuneration, perks, and grounds for termination.
- Establishing a transparent agreement ensures that all parties are on the same page and facilitates the maintenance of professionalism.
Proper Documentation: Collect W-4 forms and issue Form W-2 annually.
- Upon employment, obtain a Form W-4 from every member of the family.
- Utilize the data on the W-4 form to deduct federal income taxes accurately.,
- In addition, provide your family member with Form W-2. The annual wages and the amount of taxes withheld from their paychecks are detailed on this form.
Fair Compensation: Align salaries with market value.
- Establish a remuneration plan that corresponds with the level of expertise, skills, and position that a family member fulfills.
- They should refrain from inflating their wages artificially for the sole purpose of obtaining tax benefits. In determining compensation, fairness and market value should be the guiding principles.
Compliance with Labor Laws: Treat family members like any other employees.
- Observe labor regulations pertaining to compensation, benefits, overtime, and working hours.,
- Ensuring equitable and consistent treatment of family members in the presence of fellow employees is imperative for fostering a harmonious work environment.
How BusAcTa Advisors Can Help?
Hiring Family Member can present a challenging scenario with various tax implications. BusAcTa Advisors offers Outsourced Accounting and Tax Services to CPAs and Other Businesses in the USA, assisting in navigating these complexities. We have a skilled team that can:
- Examine your unique business framework and family employment scenario.
- Create an effective plan for minimizing taxes when Hiring Family Member.
- Make sure to comply with all tax regulations.
- Assist with Payroll Processing and tax filings.
Schedule a meeting with BusAcTa Advisors today to explore your specific situation and guarantee you’re making well-informed choices about Hiring Family Member in your company.
Read More:
1. IRS: Tax treatment for family members working in the family business
2. IRS: Family Help
