According to the U.S. Bureau of the Census, about 90% of American businesses are family-owned or controlled. Family businesses account for half of the nation’s employment, making taxes related to running a family business a pertinent issue for many small business owners. If you’re running a family business, here are some tax-related tips you need to know to optimize your deductions and maximize your return.
[Read more: 4 Written Legal Agreements Every Family Business Needs]
Taxes apply differently depending on your business entity
The IRS has different rules for family-run businesses depending on the type of entity your business operates as. Schedule C businesses, which include sole proprietorships, husband-wife partnerships, or LLCs treated as sole proprietorships for tax purposes, have different rules than S or C corporations.
Schedule C businesses are permitted to hire under-age-18 children with the child’s wages completely exempt from Social Security and Medicare (FICA) taxes and Federal Unemployment Tax Act (FUTA) taxes. This exemption applies to both the employee’s share and the employer’s share of FICA taxes — a win-win for your business and your family.
If your business is incorporated, however, your child’s wages will be subject to FICA and FUTA taxes, just like those of any other employee.
Taxes apply differently to different relatives
Not all relatives are treated the same under IRS tax rules. Spouses are treated differently than children, and rules apply to children differently depending on their ages.
“If spouses carry on a business together and share in the profits and losses, they may be partners whether or not they have a formal partnership agreement,” wrote the IRS. Spouses are subject to income tax withholding and Social Security and Medicare taxes, but they are not subject to FUTA taxes, as the proprietor and their spouse are considered a single unit, according to the Journal of Accountancy.
Keep diligent records of your family members’ wages, deductions, and taxes as you would any other employee.
Children employed by their parents will have different tax statuses based on their ages. Those who are under the age of 18 will not be subject to Social Security, Medicare, or FUTA taxes if the parents’ business is a sole proprietorship or a partnership in which both parents are partners. Children between ages 18 to 20 are treated like spouses and are only exempt from FUTA taxes. Once a child turns 21, they are subject to the same withholding taxes as any other employee.
In the event that a parent is employed by their child, the parent is subject to income tax withholding and Social Security and Medicare taxes. They’re not subject to FUTA tax. As for other family members — grandchildren, aunts, or nephews — their wages are subject to FICA and FUTA taxes like any other employee.
Take advantage of deductions in the Tax Cuts and Jobs Act
Before the Tax Cuts and Jobs Act (TCJA), a child employed at the family business was only able to take a standard deduction of up to $6,350. The TCJA doubled this provision through 2025, so that your child employee can shelter up to $12,400 of their annual wages.
“This means that your under-age-18 child will owe no federal income tax on the first $12,400 of wages for 2020 unless he or she has income from other sources. Your child can use his or her wages to help keep the family afloat financially — or to fund a college savings account or contribute to a Roth IRA,” wrote Concannon Miller.
[Read more: The 3 Keys to Success (and Failure) in Family Businesses]
It’s also worth noting that a child who earns less than the standard deduction does not owe any federal income taxes. If your child is simply working a part-time job at your family business over the summer, it may be smart to ensure their wages fall under this $12,400 threshold as it relates to the child’s potential tax burden.
Keep diligent records of your family members’ wages, deductions, and taxes as you would any other employee. Strong record-keeping protects both your business and your family from a potential IRS audit.
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Published June 23, 2022