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4 September, 2021

5 Keys to Putting Kids and Family Members on the Payroll

Whether you are a small business owner or self-employed, hiring and paying your children or grandchildren is a great strategy for minimizing your tax liability and enjoying a series of secondary benefits.

In addition to the potential tax advantages, hiring family members can provide a certain level of comfort and familiarity for the work environment. The good news is that there are no special rules when it comes to taxes that exist having to do with hiring family members at your work.

Tax Implications for Hiring Family Members

In general, you simply treat family members the same as you would any other employee with respect to necessary tax actions.  For example, you must take the following measures regarding family members and tax obligations:

  1. Obtain a W-4 form for each employed family member and withhold federal and state income taxes based on the allowances they choose.
  2. Withhold the necessary amount of FICA taxes from each family member’s paycheck. In essence, you must withhold and pay Social Security and Medicare taxes on the wages you pay your family.
  3. When you calculate the unemployment taxes (FUTA) and workers’ compensation taxes that your company must pay, you will take into consideration family member pay.
  4. When your family members work overtime for your company, you will need to pay them at the same rate as you would other employees – 1.5 times the base rate after 40 hours in a workweek.

The Federal Child Labor Act

If you are thinking about hiring your child to work for your business, you should become knowledgeable about the Federal Child Labor Act. This act provides exact guidelines having to do with when and how long children can be employed and what type of work they are allowed to do. For example, children who are younger than 14 years of age cannot work for any company, and children under 18 years old are not permitted to operate hazardous devices, in addition to many types of power tools.

Paying Children Who Are Under 18 Years Old

To begin with, you do not have to withhold any income taxes or payroll taxes from your own children and dependents under the age of 18.  This variation applies to workers’ comp, in addition to state and federal unemployment insurance. Why is this?  The government and insurance carriers assume your children will not sue if they are injured on the job. What’s more, your children are likely on your health insurance plan, which means you will pay the medical bill one way or another.

It is also helpful to know that everyone – including your children – will not pay taxes on the first $12,550 they earned, for a single taxpayer as of 2021.  This figure is adjusted for inflation annually.

It is worth noting that you can claim your children as dependents on your tax return and take the child tax credit.  However, they will not pay taxes on their earned income up to the standard deduction.

When it comes to your children working for your company, you want to make sure they are performing legitimate job services.  Keep reliable records of their work duties, as well. They can fulfill services such as filing, bookkeeping, janitorial work, etc. You should also think about creating a distinct job title and formal job description for your working child.

It is also important to pay your own children under 18 out of the correct company. For example, use your Sole-Prop operational business, LLC for rentals or a family management company (Sole-Prop) established to provide support services to your S-Corp business. It is essential that you do not pay your minor child out of an S-Corp or issue a 1099 form. A W-2 is required to avoid self-employment tax issues.

Paying Children Who Are 18 Years and Older

As with younger children, you still want to make sure your child is performing legitimate job services. They also will not pay taxes if they make less than $12,550. This strategy would also be relevant for parents, nieces, nephews, and grandchildren who are 18 and older.

Also, when it comes to employing adult children, you will need to choose between treating them as subcontractors or as employees. This translates into issuing either a 1099 or a W-2. Even if they earn less than $12,550, they should file a tax return – as they may have SE tax if you give them a 1099 form. One advantage of having your adult child filing a tax return is that way they can begin to establish a personal credit history.

An example of the above scenario is if your child is attending college, do not pay their tuition. Instead, give your child a formal role in your business as a subcontractor. Pay them for their services through a 1099 form and have them pay their own tuition.

You are still in good shape if your child earns in excess of $12,550. He or she will be in a lower tax bracket than you and can establish a small business as a support company to yours. This strategy could serve as a springboard to entrepreneurship for your child.

Paying Your Spouse

First of all, it is not a good idea to pay your spouse as soon as you are able if he or she works for your company.

The following circumstances could make you think it is fine to pay your spouse:

Saving on Taxes – You will not save on your taxes.  Paying your spouse will actually cost you taxes. If you pay your spouse, you will probably file a joint tax return, so if you pay your spouse, you could get a write-off in the business.  But it just comes back as income when you file your personal return. Then you are back where you started. What’s more, if you pay your spouse with a paycheck, you then have to withhold payroll taxes, which will cost you more.

Your Spouse will Build Social Security Benefits – It is still not worth paying your spouse. If you take the time to learn about spousal benefits and future social security benefits for the “non-breadwinner” of the family, you will understand why you should refrain from paying your spouse. Though it might be hard to believe, spousal benefits in this scenario are typically much greater than your personal social security benefits. As a result, giving your spouse a significant payroll is too costly for the paltry benefit. It is more cost-effective to claim a spousal benefit.

You Want to Contribute to Your Spouse’s 401(k) – This option is a good motivation to put your spouse on the payroll. If you do want to add to your amount in a 401(k), do some calculating and take into consideration the FICA cost of issuing a paycheck.

Available Tax Exemptions for Hiring a Family Member

You will be happy to know that there are significant tax exemptions having to do with employing a family member.

They include:

  • If your business is a sole proprietorship or limited company that’s taxed as a partnership, you can hire your child to avoid payroll tax. You can pay your child up to $12,550 a year without paying Medicare or Social Security taxes. Again, you do need to be sure your child’s work for the company is both age-appropriate and is considerable to be perceived as legitimate.
  • If another company is employing your spouse and is not in your partnership, the business owner does not need to maintain FUTA, or unemployment tax, for the spouse.
  • When a child’s business employs a parent, the child doesn’t have to maintain unemployment tax for that parent.

 As you think about the tax breaks and special rules that apply to employing a family member, you could come to realize that working with your spouse, child or parent is an ideal way to maintain your business in the family and a great way to lessen your tax burden.

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Note: The material and contents provided in this article are informative in nature only. It is not intended to be advice and you should not act specifically on the basis of this information alone. If expert assistance is required, professional advice should be obtained.

Ed Gabriel is President and Partner at DrillDown Solution. With over 20 years of experience, he holds a bachelor's degree in accounting from Brigham Young University and is a Certified Public Accountant (CPA).