While there are many factors to consider when hiring family members, there may be a few advantages from the payroll tax perspective. But, only if you are aware and perform the necessary overrides in your payroll system or notify your payroll service provider.
Let’s break this down into the types of family relationships as the advantages are different for each.
Parent employs Child – If the child is under the age of 18 and works in their parents business, their wages are not subject to Social Security (OASDI) or Medicare taxes This only if the business is setup a sole proprietorship or a partnership, and that if there is a partner who is not a parent of the child, then the partnership does not qualify and the child would be taxed. This savings alone could be a significant as the child would recognize the savings of this 7.65% combined OASDI/Medicare tax, and the business would also save on their equal share. Further, if the child is under the age of 21 and meets the same qualifications as noted above, then the employer will also save on the Federal Unemployment Tax (FUTA). No matter what the age, the child’s wages are subject to Federal Income Tax.
Based on these tax exemptions, the family unit as a whole can save over $3,000 for every $20,000 paid to a child.
The proper reporting of a W-2 to the child will include the wages paid in Box 1 with any Federal Income tax withheld in Box 2, and Boxes 3, 4, 5, and 6 would be left blank.
Child employs Parent – In cases where the child employs a parent, the tax advantages are not as significant as the previous scenario. The wages paid are subject to Federal Income tax, OASDI, and Medicare, although the FUTA exemption still holds true. A potential savings of somewhere between $42 and $420 per year based on your business’ tax rate.
Spouse employs Spouse – Similar to the Child employs Parent, the only tax savings is the FUTA tax.
Child employs Sibling – Unfortunately, there is no tax savings.
In the event the business is a corporation, then none of the tax savings apply and the wages are subject to all taxes as if no family relationship exists. This even includes corporations that are wholly owned by a parent who are employing a child.
Be sure to consult with your tax accountant or IRS Publication 15 (aka Circular E) for details pertaining to your situation as there may be further tax exemptions or limitations to the specifics of your business.