Family businesses often employ parents, children or grandchildren. If your business does, employees from your family might warrant tax exemptions that can save you big.
"One of the advantages of operating your own business is hiring family members," claims the Internal Revenue Service . "However, employment tax requirements for family employees may vary from those that apply to other employees."
The IRS includes among relatives employed by a family business spouses (including legally married same-sex spouses - check changing state laws ); directly related children, grandchildren, great-grandchildren and so on, your lineal descendants ; and ancestors. As your employees, siblings and other relatives qualify for no special tax consideration.
Many times, a family employee is treated like any other worker for tax purposes, subject to the familiar schedules of Federal Income Tax Withholding (FITW) as well as to Social Security and Medicare levies, stemming from the Federal Insurance Contributions Act ( FICA ) tax. You the employer also pay the Federal Unemployment Tax (FUTA) on each worker.
Almost everyone pays FITW income tax. In certain circumstances and depending on the family member and type of business entity, though, your family member's employment may be exempt from FICA or FUTA taxes.
Figuring out if your family members are exempt from FICA or FUTA taxes depends on the type of your business:
Sole proprietorship. Exemption sometimes applies to family member employees:
- Your daughter or son is exempt from FICA if he or she is younger than 18 and exempt from FUTA if younger than 21.
- Your spouse, as well as either of your parents, is exempt for FUTA; FICA taxes still apply.
Partnership. Each family member employee pays FICA and FUTA unless that employee is your son or daughter younger than 18 for FICA or younger than 21 for FUTA, or both, and you and your spouse are the only partners in the partnership.
Among other considerations:
- A qualified joint venture conducted with your spouse - and who along with you files a joint tax return - is not treated as a partnership for federal tax purposes. All items of income, gain, loss, deduction and credit are divided between you in accordance with your respective interests in the venture.
- Pay for the services of your child is subject to FITW withholding regardless of the child's age.
- Your child's wages are subject to all three taxes also if he or she works for an estate (even the estate of a deceased parent).
- FICA taxes do not apply to wages paid to your parent for services not performed in your business. They do apply to outside domestic services if your parent cares for your child who lives with you and is underage or requires frequent adult supervision due to a mental or physical condition - and you are a widowed or divorced or your spouse, because of a physical or mental condition, can't care for your child.
- You assume a big risk if you improperly treat a related employee (or any other worker) as an independent contractor . Generally, you withhold or pay all three of the above taxes for an employee and not for independent contractors. The IRS and state tax authorities, increasing alert to this growing and gray area of employment, can hit you with hefty penalties. If unclear about properly classifying a worker, consult your accountant or other tax professional.
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Sam Cohen, CPA, is a principal atGlass Jacobsonin Owings Mills, Md.
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