About 90% of American businesses are family owned or controlled, as reported by the U.S. Bureau of the Census. 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.
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.
[Read more: 4 Written Legal Agreements Every Family Business Needs]
Taxes apply differently to different relatives
Under IRS tax rules, there are differential treatments for relatives. Spouses are subject to different rules than children, and the regulations vary depending on the age of the children.
The IRS stated that if spouses operate a business together, sharing profits and losses, they may be regarded as partners regardless of whether they have a formal partnership agreement. As a single entity, the proprietor and their spouse are exempt from FUTA taxes, even though they are liable to income tax withholding and Social Security and Medicare taxes.
Keep diligent records of your family members’ wages, deductions, and taxes as you would any other employee.
When it comes to children employed by their parents, their tax statuses depend on their ages. If they are below 18 years, they will not have to pay Social Security, Medicare, or FUTA taxes if their parents' business is a sole proprietorship or a partnership where both parents are partners. Children aged between 18 and 20 are given the same tax treatment as spouses and are only exempt from FUTA taxes. However, once they attain 21 years of age, they become liable to the same withholding taxes as any other employee, irrespective of their relationship with the employer.
If a child employs their parent, the parent is liable to pay income tax withholding, Social Security, and Medicare taxes, but they are exempt from 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.
If your child is below the age of 18, they can earn up to $12,400 in wages for the year 2020 without incurring any federal income tax, unless they earn additional income from other sources. This allows your child to utilize their earnings to support the family financially or invest in their future by depositing funds into a college savings account or contributing to a Roth IRA.
[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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