Hiring Family In Your Small Business

Hiring family members isn’t just about trust and loyalty—it can also provide significant tax advantages for small business owners. From payroll tax savings to potential deductions, employing your spouse, children, or other relatives can help you keep more money in your pocket while staying compliant with IRS regulations. Let’s break down the potential tax benefits and how they work.

Tax Savings When Hiring Your Spouse

Hiring your spouse can open the door to a variety of tax and financial advantages:

1. Deduction of Wages Paid

   • Wages paid to your spouse are considered a business expense, just like any other employee’s wages. This means you can deduct their salary, lowering your taxable income.

   • Example: If you pay your spouse $25,000 per year, you reduce your taxable income by the same amount, potentially saving thousands in taxes depending on your tax bracket.

2. Health Insurance Benefits

   • If you provide health insurance for your spouse as part of their employment, the premiums are fully tax-deductible for your business.

   • This can save you money while ensuring your family has comprehensive health coverage.

3. Retirement Contributions

   • As an employee, your spouse can participate in a retirement plan, such as a 401(k). Employer contributions to their retirement account are tax-deductible, and this helps you build long-term savings as a family.

4. Social Security and Medicare Benefits

   • Although you must pay payroll taxes on your spouse’s wages, they will earn Social Security credits, potentially increasing their future Social Security benefits.

Tax Savings When Hiring Your Child

Hiring your children can provide even greater tax benefits, particularly for small family-run businesses.

1. Exemption from Payroll Taxes

   • Wages paid to your child under 18 are exempt from Social Security and Medicare taxes if your business is a sole proprietorship or a partnership where both partners are the child’s parents.

   • Federal unemployment tax (FUTA) is also not required for children under 21.

   • Example: If you pay your child $10,000 per year, you save approximately 15.3% in payroll taxes ($1,530), plus any FUTA taxes.

2. Lower Income Tax Rates

   • If your child earns less than the standard deduction (currently $13,850 in 2024), they owe no federal income tax. Even if they exceed this amount, their tax rate is likely much lower than yours.

   • Example: Paying your child $12,000 for legitimate work not only shifts that income to their lower tax bracket but also allows you to deduct the amount from your business’s taxable income.

3. Funding Their Future Tax-Free

   • You can use your child’s wages to fund a Roth IRA, giving them a head start on retirement savings while potentially growing tax-free for decades.

   • This is a win-win: you reduce your taxable income while helping your child build financial security.

Tax Implications for Hiring Other Relatives

Hiring parents, siblings, or other family members also comes with tax implications:

1. Payroll Taxes Apply

   • Unlike hiring a child or spouse, wages paid to other family members (e.g., siblings or parents) are subject to regular payroll taxes, including Social Security, Medicare, and FUTA.

2. Deductible Wages

   • Just like with other employees, wages paid to these relatives are fully tax-deductible, reducing your business’s taxable income.

Important Considerations for Hiring Family

While the tax benefits of hiring family can be substantial, there are a few key points to keep in mind:

1. Legitimate Work Only

   • The IRS requires that wages paid to family members must be for legitimate work performed. Paying family members without documented job duties or reasonable compensation could result in penalties.

2. Reasonable Compensation

   • The wages you pay should align with industry standards for the type of work performed. Overpaying family members could raise red flags with the IRS.

3. Proper Documentation

   • Treat family members like any other employee by collecting W-4 forms, issuing paychecks, and providing W-2s at year-end.

   • Keep timesheets and job descriptions to document the work they’ve performed.

Potential Savings Example: Hiring a Child

Let’s break down the potential tax savings of hiring a child under 18 for legitimate work, such as administrative tasks or social media management:

• Wages Paid: $10,000

• Payroll Tax Savings: $1,530 (exemption from Social Security and Medicare taxes)

• Federal Income Tax Savings: $10,000 deducted from your taxable income (saving approximately $2,400 at a 24% tax rate)

• Net Savings: Around $3,930, plus your child earns tax-free income (up to the standard deduction).

The Bottom Line

Hiring family members can be a smart financial move for small businesses, offering tax advantages and fostering loyalty and trust. However, it’s essential to follow IRS rules, properly document their work, and ensure wages are reasonable. By taking these steps, you can enjoy significant savings while building a stronger family-run operation.

Need Help Navigating Family Payroll?

At DPP Bookkeeping, LLC, we specialize in helping small businesses manage payroll, stay compliant with tax laws, and maximize their financial benefits. Contact us today or visit DPPBookkeeping.com to learn how we can simplify your bookkeeping.