Is a semi-retired parent lending your business a hand? Are your spouse or children on your payroll? Is one heir more active in the business than another? Let’s look at how the IRS treats family-member employees in these situations.
Considerations for Spouses
We know of many couples who either go into business together from the start or one will join the other in their business once it begins to grow. It’s a beautiful thing, but the taxes can get messy quickly.
If it’s a truly equal partnership in which each spouse “materially participates” in the business, the IRS allows for a qualified joint venture election. These are rare, however, because the election is akin to a sole proprietorship, which is only advised up to a certain amount of income or risk.
Alternatives are for a partnership arrangement or for one spouse to employ the other. According to the IRS, “the wages for the services of an individual who works for their spouse are subject to income tax withholding and Social Security and Medicare taxes but not to the Federal Unemployment Tax Act (FUTA).”
Employing Your Children
Most small business owners can put their children to work at a remarkably young age, Texas child labor laws withstanding, of course! Common tasks include cleaning/organizing, labeling, filing, and perhaps even some tech support (since kids tend to be more adept at understanding technology better than the rest of us).
For a parent’s sole proprietorship or a partnership in which each partner is the child’s parent, payments for services performed by the child are:
- Subject to income tax withholding (no matter the age).
- Not subject to social security and Medicare taxes if the child is under 18.
- Not subject to federal unemployment taxes if the child is under 21.
A child’s income is taxed for all other business types and situations that do not fall within these strict parameters. However, most children are not paid enough by their parents for federal income tax withholding to kick in. Your child’s income will apply to their own, separate standard deduction ($15,000 in 2025). Talk to a tax professional about best practices in this area, including setting up a job description and schedule, tax forms that will be needed, and ideas for more complicated entities like S Corps.
Succession Planning
Employing adult children who may one day take over the business is rewarding. It’s what most family business owners dream about. Adult children can be treated like any other employee regarding income and taxes, or they could be transitioned into shareholders over time, depending on your business structure. Managing multiple heirs during a family transfer can exponentially complicate things.
You’ll want to carefully plan your succession years in advance (if possible) so that you have time to structure the business and the transition for success. Consider your heirs, how active they are in the business, the most tax-advantaged way to transfer the business, how other stakeholders will be affected, and more.
Putting Parents to Work
Like spouses, parents of business owners are sometimes called upon to help out. In many cases, retired or semi-retired parents who had passed the business down return in some way, even if it’s just in an advisory capacity.
If that’s you, consider how working will affect your Social Security payments, survivor benefits, or retirement withdrawals. You may want to carefully plan out your hours or compensation so that the work doesn’t interfere with your benefits or tax rate.
We love that you love your family enough to want to work side by side. But in many cases, taxes and other business considerations come with the territory. Be proactive and create a harmonious and financially beneficial situation for everyone involved. Feel free to contact us with questions.