Employing Family Members—Tax Concerns

from the U.S. Internal Revenue Service (IRS)

One of the advantages of operating your own business is hiring family members.

However, the employment tax requirements for family employees may vary from those that apply to other employees. Here are some differences to consider.

 

Child Employed by Parents

Payments for the services of a child under age 18 who works for his or her parent in a trade or business (sole proprietorship or a partnership in which each partner is a parent of the child) are not subject to social security and Medicare taxes. Payments for the services of a child under age 21 who works for his or her parent in a trade or business are not subject to federal unemployment tax act (FUTA) tax. Payment for the services of a child are subject to income tax withholding, regardless of age.

 

Covered Services of a Child

The wages for the services of a child are subject to income tax withholding as well as social security, Medicare and FUTA taxes if he or she works for:

• A corporation, even if it is controlled by the child's parent.
• A partnership, even if the child's parent is a partner, unless each partner is a parent of the child, or
• An estate, even if it is the estate of a deceased parent.

One Spouse Employed by Another

The wages for the services of an individual who works for his or her spouse in a trade or business are subject to income tax withholding and social security and Medicare taxes, but not to FUTA tax (see Box).

Covered Services of a Spouse

The wages for the services of a spouse are subject to income tax withholding as well as social security, Medicare and FUTA taxes if he or she works for:

• A corporation, even if it is controlled by the individual's spouse, or
• A partnership, even if the individual's spouse is a partner.

Parent Employed by Child

The wages for a parent employed by his or her child in a trade or business are subject to income tax withholding and social security and Medicare taxes. Wages paid to a parent employed by his or her child are not subject to FUTA tax, regardless of the type of services provided.

If your parent works for you in your business, the wages you pay to him or her are subject to income tax withholding and social security and Medicare taxes. Social security and Medicare taxes do not apply to wages paid to your parent for services not performed in your business, but they do apply to domestic services if both the following conditions are met:

• Your parent cares for a child who lives with you and is under 18 or requires adult supervision for at least four continuous weeks in a calendar quarter due to a mental or physical condition.
• You are widowed, divorced or married to a person who, because of a physical or mental condition, cannot care for your child during that period.

The Husband-and-Wife Business Scenario

Below are some issues to consider when operating a husband-and-wife business:

How Spouses Earn Social Security Benefits

A spouse is considered an employee if there is an employer/employee type of relationship—that is, the first spouse substantially controls the business in terms of management decisions, and the second spouse is under the direction and control of the first spouse. If such a relationship exists, then the second spouse is an employee subject to income tax and FICA (social security and Medicare) withholding. However, if the second spouse has an equal say in the affairs of the business, provides substantially equal services to the business and contributes capital to the business, then the partnership-type of relationship exists and the business' income should be reported on a U.S. Return of Partnership Income form 1065.

Both Spouses Carrying on the Trade or Business

If spouses carry on a business together and share in the profits and losses, they may be partners in a partnership whether or not they have a formal partnership agreement. Spouses should report income or loss from the business on the U.S. Return of Partnership Income form 1065. They should not report the income on a Profit or Loss From Business form 1040 Schedule C in the name of one spouse as a sole proprietor.

If each spouse is a partner in a partnership, each spouse should carry his or her share of the partnership income or loss from Form 1065, Schedule K-1, Partner's Share of Income, Credits, Deductions, etc., to their joint or separate Form(s) 1040. Each spouse should include his or her respective share of self-employment income on a separate Form 1040 Schedule SE, Self-Employment Tax. Self-employment income belongs to the person who is the member of the partnership and cannot be treated as self-employment income by the nonmember spouse, even in community property states. This generally does not increase the total tax on the return, but it does give each spouse credit for social security earnings on which retirement benefits are based. However, this may not be true if either spouse exceeds the social security tax limitation.

One Spouse Employed by Another

If your spouse is your employee, not your partner, you must pay social security and Medicare taxes for him or her. The wages for the services of an individual who works for his or her spouse in a trade or business are subject to income tax withholding and social security and Medicare taxes, but not to FUTA tax.

Information from the Internal Revenue Service website, www.irs.gov.

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