Hire family members in a small business
In the 1972 movie The Godfather, Don Vito Corleone preferred his son Michael to pursue a political career. Michael ignored his father’s wishes and instead decided to enter the family business, so to speak. Ninety percent of American businesses are family owned (and legally operated) and, unlike Don Corleone, many business owners welcome the prospect of keeping their businesses within the family unit. While hiring family members can have some potential downsides, the practice can also bring great benefits. Advise your clients to consider the following factors before choosing to hire a relative.
1. Not all parents are equal
Relatives of employees do not all have the same legal status. The rules change depending on the nature of your clients’ family relationship with their employee and the age of the employee. “Spouses are treated differently than children, and children are treated differently depending on their age,” said Nicole DeRosa, CPA, senior tax manager at Wiss & Company.
DeRosa explained that while spouses are subject to income tax withholding and Social Security and Medicare taxes, they are not subject to federal income tax law taxes. unemployment (FUTA). In this respect, the owner and his spouse are considered as one unit.
The status of children employed by a parent varies according to their age. Children under 18 are not subject to Social Security, Medicare, or FUTA taxes if the parent’s business is a sole proprietorship or a partnership in which each partner is a parent of the child. Children between the ages of 18 and 20 are treated as spouses – they are part of the family unit and are only exempt from FUTA taxes. Once a child turns 21, they are treated no differently than any other employee. At this point, the children are subject to the same withholding taxes as any other employee.
If a parent is employed by their child, the parent is subject to income tax withholding and Social Security and Medicare taxes from their wages, but is not subject to FUTA taxes on those. this.
2. Tax implications can work in your favor
Jeffrey Levine, CPA/PFS, director of planning at Buckingham Strategic Wealth, pointed out that hiring their underage children can bring definite tax benefits to parents. “It is important to inform your clients that the so-called child tax will not apply if a business operator hires their child – earned income is not subject to child tax.”
Levine further observed that a child who earns less than the standard deduction owes no federal income tax. In 2022, this equates to $12,950 per child sheltered from tax annually. The parent may also declare the child as a dependant.
Finally, Levine noted that hiring a minor child jump-starts the savings process. “The money your parents earn working is earned income,” Levine said. “As such, these funds can be paid into an Individual Retirement Account.” The cumulative effect of saving money at such a young age can be significant, and the best choice may be a Roth IRA.
3. Make sure they’re ready for the job
If your clients are hiring their children, advise them to make sure the work is legitimate and age-appropriate. Levine warned against phantom payroll systems. “Hiring a parent is no excuse to cut off a paycheck and not expect them to show up,” he said. “The work must be real.”
Levine added that business owners need to consider their children’s ages when assigning them work. “There are exceptions to employment law for family members, but you can’t let a small child operate heavy machinery.” Examples of age-appropriate work Levine provided included modeling clothes for babies and toddlers and scanning and photocopying for elementary school children.
The salary must also be appropriate and reasonable. “Just because your employee is related to you doesn’t mean he’s carte blanche pay what you want,” DeRosa said. “The salary must correspond to the work.
4. Watch out for traps
According to Brian Preston, CPA/PFS, managing partner of Abound Wealth and host of The Money Guy Showwhile hiring a relative can be rewarding, it can also undermine the morale of the rest of the staff.
Preston stressed that business owners should fight the temptation to give special treatment to loved ones. “Don’t pay your child twice as much as everyone else,” he advised. “News will come out, and it will breed resentment.”
Preston suggested that, if possible, business owners encourage their children to gain work experience in another organization before hiring them as senior employees. “That way,” he explained, “they have already developed a level of fluency and can largely avoid impostor syndrome.”
In the end, family relationships trump money. “Unfortunately, money can separate people,” Preston observed. “Many of my clients are father-son teams in the manufacturing industry. I’ve seen business disagreements poison close relationships.” Make sure your customers understand that they risk straining their relationships if difficulties arise in their business arrangement.
In summary, for the responsible business owner, hiring parents is a viable option. Encourage your clients to consider all factors, financial and otherwise, before deciding to hire family members to work in their business. Despite some potential downsides, involving family can be a personally rewarding and financially rewarding decision.
For more on tax and financial considerations when employing relatives, see Young (ed.), “Employing Family Members,” 50 The tax advisor 800 (November 2019).
— Joshua Wiesenfeld, CPA, is a New Jersey-based forensic accountant. To comment on this article or suggest an idea for another article, contact Dave Strausfeld at [email protected].