Randy J. Elder, CPA, P.C.

Tax benefits when employing family members in your small business

As a small business owner, you may have the opportunity to help out family members by offering them employment in your business. While everyone knows there can be certain challenges associated with hiring family members, there are also many benefits. In addition to helping the family member financially and giving them work experience, or with other words employing them, there are also a number of tax-related benefits.

Employing your family members

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Let’s look first at employing a child, one of the more common scenarios. If you employ one of your children, you can reduce your self-employment income and taxes by shifting earned revenue from you, the business owner, to your child. Earned income is taxed at the child’s marginal rate, and the earned income is reduced by the lesser of the earned income plus $350 or the regular standard deduction for the year, which is $6,200 for 2014. If your child has no other income, you could pay him or her up to $6,200, and they would incur no income tax. If your child earned more than $6200 while working at your business, the next $9,075 is taxed at 10%.

Here is an example of how the numbers work: Let’s say you are in the 25% tax bracket and own an unincorporated business. You hire your 13-year-old daughter (who has no investment income) and pay her $10,000 for the year. You reduce your income by $10,000, which saves you $2500 of the income tax (25% of $10,000). Therefore, your daughter has a taxable income of $3,800 ($10,000 less the $6,200 standard deduction), on which the tax is $380 (10% of $3,800).

Of course, the employment must be legitimate and the pay reasonable with the hours and the job worked. For example, you can’t pay your 13-year-old daughter $50 per hour to clean floors or stock shelves. If you want to put your kids to work in your small business, just make sure you are paying a reasonable market rate for tasks performed.

Another area of possible tax savings when employing a child comes into play with FICA. The wages paid to a child under age 18 while employed by a parent will not be subject to FICA—Social Security and Hospital Insurance (aka Medicare or HI). That means your child will not be required to pay the employee’s share of the FICA taxes, and you, as the business owner, will not have to pay your half either.

A similar exemption exists for FUTA. Earnings paid to a child under age 21 while employed by his or her parent has an exemption from federal unemployment tax. The FICA and FUTA exemptions apply if your business is unincorporated or a partnership consisting solely of the child’s parents.

Finally, there may be retirement plan savings available when employing one of your kids in your small business. If the child is paid more (or works more than part-time), they can take the extra earnings and make a tax-deductible contribution up to $5,500 into their own IRA. You also might be able to provide, through your business, your employee-child with retirement plan benefits depending on the type of plan, terms, the child’s age, and the number of hours worked. By combining the standard deduction ($6,200) and the maximum deductible IRA contribution ($5,500) for 2014, your child could earn $11,700 of wages and pay no income tax.

You might also employ or consider hiring a spouse in your small business. Doing so can also provide tax benefits. The wages paid to your spouse are subject to FICA taxes. Depending on your situation and as a result of employing your spouse they may now qualify for Social Security benefits to which he or she might not otherwise be entitled. Also, your spouse may also be eligible to receive coverage under your business’s qualified retirement plan, and you as the employer-spouse may obtain a business deduction for health insurance premium payments made on behalf of your employed spouse. While maintaining the same family coverage, the business deductions could be increased by providing your spouse with family health insurance coverage as an employee.

If you have questions about these and other possible tax benefits or issues related to hiring your spouse or child, please give me a call