Do you need help in your practice? Have you considered hiring your spouse or child to complete office work? Hiring family members, especially children, can lead to payroll tax exclusions and business deductions for wages paid. In this article, we’ll explore the tax implications of hiring family members in your practice, including the specific IRS guidelines that you need to follow to remain compliant.
The Tax Benefits of Hiring Family Members
Hiring family members can be a great way to get work done in your practice while providing employment opportunities for your loved ones. Outside of the convenience of working with family, there are a few tax benefits that can make hiring family members a sound financial decision, including:
- Payroll Deductions – Gross wages and employer payroll taxes are deductible as business expenses.
- Retirement Contributions – Paying family members a wage results in earned income, which can be used to make retirement contributions.
- Tax-Free Pay – In some situations, such as when hiring children, the pay is excluded from Social Security, Medicare, and FUTA (ie: federal unemployment) taxes.
- Income Shifting – When you pay family members, income is staying within the family, which can be advantageous when building long-term wealth.
Outside of these tax benefits, hiring family members can also add trusted employees to your team, resulting in lower turnover, greater business dedication, and fewer onboarding costs.
Key Requirements for Hiring Family Members
Many of the payroll caveats are the same as standard employees when hiring family members; however, spouses and children do have a few key differences. Here are the important requirements the IRS has in place when hiring family members.
Children Employed by Parents
The taxability of wages earned by children depends on your practice structure. If your practice is set up as a sole proprietorship or partnership where each parent is a partner, wages paid to children under the age of 18 are not subject to Social Security or Medicare taxes. Additionally, if the child is under the age of 21, they are exempt from FUTA taxes. Ordinary income tax withholding applies regardless of age. If your practice is set up as a corporation or a partnership with non-related partners, there are no exclusions from Social Security, Medicare, or FUTA.
Outside of these tax withholding specifications, you must comply with all employment laws, including minimum age requirements, obtaining child labor permits, and restricting hours. Check with your state’s department of labor for the specific requirements you need to follow.
Parents Employed by Children
Parents employed by their child’s sole proprietorship are excluded from FUTA taxes, but are subject to Social Security and Medicare. All other practice structures, including corporations and partnerships, have no payroll tax exclusions.
Spousal Considerations
Married couples working in the same practice have tax benefits similar to children employed by parents. The wages paid are only exempt from FUTA taxes.
All Other Family Members
Outside of the above categories, there are no payroll tax exclusions. This means that hiring a sister, brother, aunt, grandparent, cousin, or other type of family member results in payroll being treated the same as any other employee. However, you can still leverage other benefits, like claiming business deductions for wages and employer payroll taxes.
Payroll and Documentation
If you decide it’s time to add a family member to your practice, there are a few payroll and documentation considerations. First, ensure that the wage is appropriate for the position. For example, hiring your sister to work at the front desk wouldn’t warrant a pay rate of $100 per hour. Instead, the pay must be reasonable for the duties performed. Second, be sure that you are paying justifiable wages each pay period. This can be done by requiring your family member to track time and document the completed tasks.
It’s also important to properly set up your family members in your payroll system. Family members who perform regular duties are often considered employees, not independent contractors. This means that both you and your family member are required to pay payroll taxes on earned wages, unless the individual qualifies for an exclusion. At year-end, your family member will be issued a payroll tax form to report on their own income tax return.
Balancing IRS Scrutiny and Benefit Maximization
Hiring family members can have some great advantages for your practice. Not only can your spouse or children earn income that counts towards retirement contribution requirements and Social Security work credits, but you can also leverage business tax deductions and minimize (or eliminate) FICA and FUTA taxes. Due to the tax benefits, the IRS closely monitors payroll for family members.
Take the time to research a reasonable pay rate for the duties performed and work with a financial advisor to find the right amount of pay. For example, if your primary goal of hiring your spouse is to unlock additional retirement contributions, you may want to structure pay around the maximum contribution amount.
If you have questions about the tax implications of hiring family members in your practice, please contact us.