Hiring and employing family members is common in the realm of family businesses. An important thing to remember is that most family employees are treated in the same manner as any other employee for federal tax purposes, meaning that their compensation generally is subject to federal income tax withholding and FICA (i.e., social security and Medicare) and FUTA (i.e., unemployment) tax. However, the wages of certain family members are exempt from FICA and FUTA taxes. A family business may be able to reduce the overall family tax burden by employing family members in the following situations, among others.
Child working for a parent. Parents running a family business often will employ their children. Payments for services performed by a child for their family’s business are exempt from FICA tax if the child is under the age of 18 and the business is a sole proprietorship of a parent or a partnership in which each partner is a parent. A more liberal exemption applies in the case of FUTA tax, which exempts payments for services performed by a child for a parent while the child is under the age of 21. Limitations do apply. For example, these exemptions generally are not available if the family business is incorporated or is conducted through a partnership or limited liability company that includes as a partner or member someone other than the child’s parents. Of course, even in those situations, there may be a benefit to a family business employing a child, as there’s no extra cost to the business if paying the child for work that the business would pay someone else to do anyway.
Spouse employed by his or her other spouse. A spouse running a family business may also want to employ his or her spouse. The wages for the services of a spouse working for his or her spouse’s business are subject to federal income tax withholding as well as FICA tax. Such wages are, however, exempt from FUTA tax. As is the case with the wages of minors, this exemption is subject to limitations. It is generally not available if the business is incorporated or conducted is through a partnership or limited liability company, even if the individual’s spouse is a partner or member.
Brian Todd focuses on federal income tax issues in a wide variety of corporate, LLC, partnership, and international transactions. He drafts economically complex LLC operating agreements and has extensive experience in the formation, organization, and taxation of LLCs and partnerships. Brian regularly advises clients on tax considerations and disclosures related to corporate mergers, acquisitions and IPOs. Brian can be reached via email at briantodd@dwt.com or directly at 206.757.8157.