As we move into the last quarter of 2021, we wanted to give you some small business tax tips to help you close out your year successfully. In this post, we’ll focus on everything you need to know about employing family members and how that affects your taxes.
Starting and operating a small business can be full of excitement and anxiety. The thrill of turning your passion into a profitable enterprise is one of the main reasons people get into business for themselves. At the same time, the challenges of managing it well and staying on top of taxes and regulations can be extremely frustrating.
It can only get more interesting (and possibly more frustrating?) when you add family into the mix!
Small Business Tax Tips When Working With Family
The Motley Fool has a really good guide to “Small Business Tax Deductions You Should Know.” We think it is definitely worth a read. However, it isn’t an exhaustive list. One area of possible tax savings that they didn’t include is when you have family members who are also you employees.
Many entrepreneurs start out their small businesses by hiring family members. Since most small businesses begin at home—often in the garage or at the kitchen table—that makes sense.
Family members can be an easy source of labor:
- You already know them.
- They’re already familiar with your business.
- They’re personally invested in its success.
- They don’t have far to commute to work.
- You (hopefully) like them enough to spend hours each day working side by side.
So here are some small business tax tips to keep in mind when it comes to hiring family members to work with you.
1. You can deduct for “reasonable compensation.”
If an employee is also an immediate family member, you can reduce your taxable income by deducting what you pay them just as you would any other employee.
Section 162(a) of the Internal Revenue Code states: “There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including…a reasonable allowance for salaries or other compensation for personal services actually rendered;”
Unfortunately, many people try to pass money to family members under the guise of “employment.” It’s a scheme that the IRS is well aware of and on the lookout for.
It usually looks like this: paying a relative significantly more than the duties they perform would be worth if they were being done by an unrelated person. (e.g. your child makes deliveries for your dry cleaning business but gets paid more than the manager.)
You should structure the compensation of family members just the same as you would for anyone else. You may plan to start them at the “ground level” and move them up through the ranks quickly so that they eventually can take over the business, but be sure to pay them appropriately along the way.
2. You may not have to pay FICA or FUCA.
As an employer, you are responsible for paying Federal Income Contributions Act (FICA) and Federal Unemployment Tax Act (FUTA) taxes on each of your workers. However, depending on their relationship to you, you may not have to pay some or any of these taxes on family members who work for your company.
For the official details from the IRS, read their page on “Tax Treatment for Family Members Working in the Family Business.” The IRS has also put together a helpful 2-minute video on the topic that you can watch here.
Basically, you may not have to pay FICA or FUTA if:
- Your child working for you is under age 21. (FUTA is not required.)
- Your child working for you is under age 18 and the business is a sole proprietorship or a partnership owned by both parents. (FICA and FUTA are not required.)
- Your spouse works for you. (FUTA is not required.)
- Your parent works for you. (FUTA is not required.)
3. You still have to follow child labor laws.
Even though the children in question working for you may be your own, as an employer you are responsible for following all federal and state child labor laws.
For more helpful information from the Department of Labor when it comes to hiring minors, check out the YouthRules! page on their website.
According to the Fair Labor Standards Act (FLSA):
- Minors under age 14 may not be employed.
- Minors age 14-15 may only work in a limited number of occupations.
- Minors age 14-15 may work after school in certain non-hazardous jobs
- No more than 3 hours on a school day;
- No more than 18 hours in a school week;
- No more than 8 hours on a non-school day;
- No more than 40 hours in a non-school week
- Minors under 16 may not work before 7:00 a.m. or after 7:00 p.m. (except between June 1 and Labor Day when the end time is 9:00 p.m.)
One Post About Small Business Tax Tips Will Only Take You So Far
Closely held businesses receive much greater scrutiny from the IRS, so you need to be sure that you’re following the law properly when dealing with family. A good rule of thumb to keep in mind is to try to keep those working relationships at “arms-length” as much as possible.
At CRS CPA, we regularly partner with small businesses that enjoy having family members work alongside them. It’s great to see work and family blend together in rewarding relationships.
Our Payroll & HR Professionals understand the ins and outs of making sure your family members/employees are handled correctly. If you have any questions about whether or not your business is doing it right, schedule a call with us today and let us help you make sure!