Family Business Payroll: Taxes, Rules, and How to Set It Up

Running a family-owned business requires a delicate balance between personal and professional life, but it comes with perks. One of the key benefits is a family business payroll, which can offer some tax advantages while helping your spouse, children, siblings, and other members.

This article examines the rules and regulations governing the employment of family members on the payroll. We’ll see what the IRS says on the topic and what some special cases to be aware of are. We’ll also help you set up the payroll system and determine fair wages for family members.

Key Takeaways

• You can legally hire and pay family members, and even gain some tax-related benefits by doing so.
• In some cases, wages for family members can be exempt from FICA and FUTA taxes, but they are typically subject to federal income tax withholding.
• You can’t pay your family members in cash under the table. Instead, you must keep records of every payment and issue relevant documents (e.g., pay stubs and Form W-2).
• Use Paystub.org document generators to streamline your payroll system and effortlessly create pay stubs and Form W-2.

Can You Hire and Pay Family Members?

Yes, you can legally hire and pay family members like any other employees. This includes your spouse, children, siblings, and parents. Hiring family members is a common practice in many small businesses, especially when starting out. It provides a degree of certainty and predictability compared to hiring an unknown person.

The key to hiring family members is to treat them like any other employees. That’s because the Internal Revenue Service (IRS) and the Department of Labor (DOL) both look at hired family members as employees for tax and legal purposes.

For example, that means you should complete the same paperwork as you would if you hired a non-family member. This includes Form I-9, or Employment Eligibility Verification, and Form W-4, or Employee’s Withholding Certificate. Following that, you need to keep detailed records of the work your family member does, including their hours and duties.

All of this is critical in establishing a legal and professional employer-employee relationship with the family member. This is particularly important if employing minor children, since there are various state and federal laws regarding working conditions and hours made to protect them.

By adhering to the regulation, you’ll avoid issues during audits while safely and legally leveraging any potential tax benefits for which you and hired family members are eligible.

IRS Rules for Family Business Payroll

The IRS has specific rules regarding the hiring of family members and their inclusion on payroll. Some of them offer tax advantages, although the rules vary depending on the family member and their age.

For instance, if you hire a child who is under 18, you don’t have to withhold Social Security and Medicare taxes (FICA taxes) from their paycheck.

Similarly, if a child is under the age of 21, they are exempt from the Federal Unemployment Tax Act (FUTA tax). Wages given to spouses are also exempt from FUTA tax, but not from FICA taxes. In the same manner, if a child is employing their parent, the wages are subject to income and FICA taxes, but not to FUTA tax.

Keep in mind that most of these rules only apply to sole proprietorships and partnerships, and only to those partnerships where both parents are partners. If the type of business is a corporation or a partnership, where one of the partners isn’t a child’s parent, regular tax rules apply.

Regardless of the business form and professional relationship, you must provide a Form W-2 for family members to everyone at the end of the year. These documents detail their earnings and taxes withheld, helping them file their tax returns.

You must also collect Form W-4 from each family member whom you hire. The information provided on these forms will help you calculate the correct federal income tax withholding. These taxes are mandatory for all wages, regardless of FICA or FUTA exemptions.

How to Set Fair Wages for Family Members

Setting fair wages for family members requires a careful balance of business needs and family dynamics.

Apart from that, the compensation must be within reasonable limits to ensure compliance with the IRS and not raise any red flags. For instance, paying a family member an unusually inflated or reduced salary might be viewed as an attempt to reduce taxes or as an illegal distribution of profits.

Also, while paying family members who do not work is technically legal, it can result in audits and scrutiny, as that tactic is sometimes used fraudulently.

The first step in setting fair wages as part of your family business payroll should be to check the market rates. Start by creating a detailed job description for the role for which you want to hire a family member. Then, research what the other companies in your region and field of work are paying their employees who have similar positions and responsibilities.

You can utilize various online databases and surveys to obtain precise data and compare it to the positions within your company. The compensation should be tied to each family member’s responsibilities and contributions to your business.

You should also conduct regular performance reviews to assess the value your family members bring and adjust their salaries accordingly. The important thing is to remain objective in the matter and make decisions as a professional, without allowing personal feelings to interfere.

Lastly, maintain open and transparent communication, with clearly written policies for all employees. This will help you create a harmonious workplace and a motivated workforce, especially if you’re employing non-family members, as well.

How to Set Up Family Business Payroll

Setting up a family business payroll is a must before you can start paying family members in a small business. It’s essential in ensuring the tax and legal compliance of your enterprise.

Here are the vital steps:

• Get an Employer Identification Number (EIN). If you don’t have one (e.g., you’re only starting your business), you should get an EIN from the IRS. This number is required to report taxes and file various other documents.

• Register for state payroll taxes. You must register your business with your state’s Department of Revenue and the State Workforce Agency (SWA), as they are responsible for handling state income tax withholding and state unemployment (SUTA) taxes.

• Complete the paperwork. You should receive a filled-out Form W-4 for tax purposes from each family member you hire, and you should file a Form I-9 to verify their eligibility to work.

• Classify family members correctly. Correct employee classification for family members is critical in avoiding problems with the IRS. Family members will typically be employees, rather than independent contractors. Misclassification is a serious offense that can lead to significant penalties.

• Set up the payroll schedule and system. Establish a consistent pay period (e.g., weekly or bi-weekly), track your employees’ hours worked, and calculate earnings, deductions, gross, and net pay. Using payroll software for small businesses can help you streamline these processes.

Special Cases of Paying Spouses and Children

The IRS has several special rules when it comes to payroll tax for family businesses. Familiarizing yourself with them can help you achieve significant tax savings.

Let’s start with the special cases for when parents employ their children in their private home:

• Payments aren’t subject to income tax withholding if the child does domestic work in the parent’s private home.
• Payments aren’t subject to FICA and FUTA taxes if the child is under 21.

If parents employ children as sole proprietors or partnerships:

• Payments are subject to income tax withholding, regardless of age.
• Payments aren’t subject to FICA taxes for children under 18.
• Payments aren’t subject to FUTA tax for children under 21.

If parents employ children and they own a corporation, payments are subject to income, FICA, and FUTA taxes, just like with regular employees.

If a child employs their parents as a sole proprietor, payments are subject to income tax withholding and FICA, but not FUTA tax. If they own a corporation and hire a parent, their wages are subject to all taxes.

When it comes to married couples in business, they can do so in various ways, each coming with different tax benefits and requirements. That’s why it’s important to do your research to find the best way to pay your spouse in a business.

4 Common Mistakes to Avoid When Paying Family

Let’s explore the most common mistakes you can make when setting up a family business payroll.

#1. Paying in Cash With No Records

Paying in cash (also known as paying “under the table”) with no records is considered tax evasion and is illegal. When caught, you’ll likely face severe penalties, which can include back taxes with interest, along with fines. Depending on the severity of the offense, you can also face criminal charges.

That’s why it’s imperative to pay your family members through proper channels and to keep accurate records of all transactions. This will help you stay compliant and avoid trouble during audits.

#2. Failing to Issue W-2s

Every employee, including family members, should receive a Form W-2 at the end of the year. This document details their earnings and taxes withheld, helping them calculate how much is left for them to pay in tax before filing their return. Copies of W-2s shouled also be sent to the Social Security Administration.

#3. Treating the Family as Contractors

Treating hired family members as contractors when they are employees is considered worker misclassification and is a compliance risk. The IRS has set guidelines you can follow to determine whether a family member can be classified as a contractor. In general, if you have significant control over their work and behavior, they are likely your employees.

#4. Not Withholding Taxes

While some exceptions apply in certain cases, you’re still usually required to withhold federal and state income taxes from wages. Not all family members that you hire are automatically exempt from tax withholding, and failing to do so will result in non-compliance and penalties.

How Paystub.org Can Help with Family Business Payroll

Paystub.org can help with your family business payroll by offering document generators you can use to streamline your processes. We offer:

• Pay stub generator. Generate professional and accurate pay stubs for family employees by choosing the template and filling it in with relevant details.

• Form W-2 generator. Create one or more W-2 forms to help your family members file their tax returns.

• Form 1099 generator. Document payments made to contractors with an intuitive and robust Form 1099 generator.

• Invoice generator. Effortlessly bill clients and improve the cash flow of your family business with professional invoices.

Final Thoughts

Managing your family business's payroll is not much different from managing a regular payroll for any company. By treating your family members as employees and maintaining accurate records of all transactions, you’ll ensure regulatory compliance and avoid potential problems during audits.

Depending on the family member that you hire, you may be eligible for some tax-related benefits. However, you should do a thorough research to avoid making costly mistakes. Lastly, don’t forget to check out our document generators if you want to streamline your payroll and other business operations.

Family Business Payroll FAQ

#1. Can I pay my spouse under the table?

No, you can’t pay your spouse under the table, as that would be illegal. Paying anyone under the table constitutes tax evasion and can lead to severe financial and legal penalties from the IRS.

#2. Do I have to pay my child minimum wage?

In most cases, you have to pay your child minimum wage or more. The Fair Labor Standards Act (FLSA) establishes a minimum wage for employees, including children. While there may be some exceptions, it’s best practice to pay them a reasonable wage.

#3. At what age can I put my child on payroll?

You can put your child on payroll at the age of sixteen, which is the minimum age for employment. Children aged fourteen and fifteen can be employed outside school hours for limited periods and in non-hazardous jobs.