Many small businesses employ family members. The IRS has specific rules for family employees, described on its page about family help and in Publication 15. The rules turn on who is employed and how the business is organized.
Children employed by a parent
Payments for the services of a child under age 18 who works for a parent in a trade or business are not subject to Social Security and Medicare taxes, if the business is a sole proprietorship or a partnership in which each partner is a parent of the child. Payments to a child under 21 in such a business are not subject to federal unemployment tax. Wages are still subject to income tax withholding if the child's earnings require it.
These exemptions do not apply if the business is a corporation, including an S corporation, or a partnership with partners who are not the child's parents. In that case the child is treated like any other employee.
Spouse employed by the other spouse
Wages for the services of a spouse who works for the other spouse's business are subject to income tax withholding and Social Security and Medicare taxes, but not to federal unemployment tax. Again, if the business is a corporation, normal rules apply.
Parents employed by a child
Wages paid to a parent employed by their child's business are subject to income tax withholding and Social Security and Medicare taxes, but not FUTA.
Spouses who co-own a business
Spouses who jointly own and operate an unincorporated business are generally partners, not employer and employee. A qualified joint venture election may let them file as two sole proprietors instead of a partnership return in certain situations.
The work must be real
Family wages must be for actual services, at a rate reasonable for the work performed. Paying a young child an adult professional's wage, or paying for work that was never done, will not hold up. Keep records that a non-family employee would have:
- A job description and pay rate
- Timesheets or logs of hours
- Payment by check or transfer from the business account to the family member's own account
- W-4 and I-9 forms
State rules
States follow their own rules for unemployment insurance and withholding of family employees, which may differ from federal treatment.
Our approach
We set up family members in payroll with the correct taxability flags for your entity type, so exemptions are applied only where they are allowed. See our payroll services and our guide to how to run payroll for the first time.
Documentation checklist
- Job description and timesheets
- Pay rate comparable to an unrelated worker
- Payroll records and W-2s or 1099s as applicable
- Proof payments were actually made from the business account
Children working in the business
Payroll tax treatment of a child employed by a parent can depend on the child's age and the business entity type. The IRS explains the rules on its family help page. Child labor laws on hours and permitted tasks still apply.
Pay family members on the same schedule as other staff, and avoid round lump sums that look unrelated to work performed.
