Key Takeaways:
- Hiring family in your business can provide trust, reliability, and flexibility, making it easier to fill roles and support household income.
- Minor children employed in sole proprietorships or parent-only partnerships can offer payroll tax savings, including exemptions from Social Security, Medicare, and FUTA taxes.
- Wages paid to family members are deductible if they are reasonable, documented, and reflect actual work performed, with fringe benefits like retirement and health plans adding long-term value.
- Business entity type affects tax savings: corporations cannot claim minor-child exemptions, while sole proprietorships and parent-only partnerships can.
- Common mistakes include misclassifying family as contractors, overpaying, failing to track hours, and ignoring state labor laws, all of which can trigger audits or disallow deductions.
- Following best practices, like setting market-based wages, tracking work, running payroll properly, and consulting tax professionals, helps maximize benefits and stay IRS-compliant.
Hiring family in your business can feel like a natural choice. Many entrepreneurs start small and lean on spouses, children, or parents to help keep things running. For some, it’s about trust and loyalty, knowing you can count on a family member to care about the business as much as you do. For others, it’s about flexibility and creating opportunities for their loved ones. On the financial side, there are also legitimate tax savings that can come with putting family members on payroll, from income-shifting strategies to retirement and benefit planning. But it’s not all upside. The IRS keeps a close eye on these arrangements, and the rules change depending on who you hire and how your business is structured. In this article, we’ll break down the tax advantages of hiring family in your business, the drawbacks that often get overlooked, and the compliance best practices that help protect you in the long run.
Why Business Owners Hire Family Members
When thinking about hiring family in your business, most owners start with trust and practicality. Family members can often step into roles more quickly, require less training, and have a vested interest in the business’s success.
Beyond these personal reasons, there are financial considerations. Paying family members can shift income to lower tax brackets, fund retirement accounts for younger employees, and offer deductions for the business. But it’s important to approach these hires like any other employee: define roles, track hours, and pay reasonable wages. Without proper documentation, the IRS may challenge deductions or question payroll practices.
Trust and Reliability
Family members often provide a level of reliability that outside hires may not. They are more likely to go the extra mile during busy periods, cover shifts at the last minute, and maintain confidentiality about sensitive business information.
Flexibility and Shared Goals
Hiring family in your business allows for flexible scheduling and collaboration on growth strategies. Family members may be more willing to adjust hours or take on new responsibilities, and they are invested in the long-term success of the business.
Financial Support and Household Income
By putting family members on payroll, owners can provide meaningful financial support. This may include paying children for part-time work, helping a spouse contribute to retirement savings, or even assisting aging parents with supplemental income. Tax laws often make these wages deductible, further reducing the household’s overall tax burden.
Tax Advantages of Hiring Family in Your Business
The tax benefits of hiring family in your business can be significant, but they depend on the relationship, age of the employee, and business entity. Understanding the specific rules is key to maximizing savings.
Income Shifting to Lower Tax Brackets
One of the most common strategies for hiring family in your business is income shifting. By hiring your kids or other family members a reasonable wage for actual work, you move taxable income from a higher bracket to a lower one.
For example, a business owner in the 32% tax bracket pays their 16-year-old child $10,000 for marketing and fulfillment tasks. The wages are deductible for the business, and the child’s federal income tax liability may be zero after the standard deduction, effectively lowering the family’s overall tax burden.
Payroll Tax Savings for Minor Children
If your business is a sole proprietorship or a partnership where each partner is a parent of the child, wages paid to children under 18 are exempt from Social Security and Medicare taxes. Additionally, wages paid to children under 21 in these same setups are generally exempt from federal unemployment tax (FUTA). These exemptions do not apply for corporations or partnerships with non-parent partners.
For example, a sole proprietor pays a 17-year-old $8,000 for weekend and summer work. These wages are deductible, and FICA and FUTA taxes are not applied, providing meaningful payroll savings.
Deductible Wages and Fringe Benefits
Wages paid to family members are deductible if they are ordinary, necessary, and reasonable for the services performed. Reasonable means what you would pay a non-family worker with similar skills for the same job in your market. Fringe benefits like retirement contributions or health insurance may also be deductible if offered consistently to other employees and allowed under your plan.
Tax Drawbacks and Complications of Hiring Family in Your Business
While hiring family in your business can offer tax benefits, there are also significant complications to be aware of. Payroll obligations, compliance requirements, and IRS scrutiny can reduce or eliminate potential savings if rules are not carefully followed.
Payroll Taxes Still Apply in Most Cases
Outside of minor children in sole proprietorships or qualifying parent-only partnerships, wages paid to family members are subject to standard payroll taxes, including FICA and FUTA. Corporations, including S corps and C corps, cannot take advantage of minor-child exemptions.
Reasonable Compensation Rules
Wages must reflect actual work performed at market rates. Overpaying family members to create a deduction can trigger IRS audits and penalties. Documenting work hours, tasks, and deliverables is critical. For instance, paying a 14-year-old $50,000 for a few hours of summer work is unreasonable and may result in disallowed deductions.
Documentation and Compliance Burden
Hiring family requires the same employment documentation as any other hire: payroll setup, tax withholding, I-9 verification, W-4 forms, and timesheets. State labor laws, including minimum wage and child labor permits, still apply. Failure to maintain proper documentation can lead to audits or fines.
Limited Savings for Spouses and Adult Children
The most significant payroll tax advantages are for minor children in sole proprietorships or parent-only partnerships. Spouses and adult children typically face standard payroll taxes, although wages remain deductible and retirement benefits can still be valuable.
Entity Type Considerations
The type of business entity significantly affects tax savings. Sole proprietorships and parent-only partnerships preserve exemptions for minor children, while corporations do not. Entity choice should align with long-term business strategy as well as family employment goals.
Special Considerations by Family Member
The IRS rules for family employment differ based on the employee’s age and relationship to the business owner. Understanding these distinctions is key for maximizing legitimate tax benefits while avoiding compliance issues.
Children Under 18
Children under 18 employed by a parent’s sole proprietorship or parent-only partnership are exempt from FICA and FUTA taxes. Income tax withholding still applies, but children may owe little to no federal income tax due to the standard deduction. For example, say a 16-year-old works part-time packing and shipping orders. Their wages are deductible for the business, and payroll tax savings are realized.
Children Ages 18–20
Once a child turns 18, FICA taxes apply, but FUTA may still be exempt until 21 in certain parent-employer structures. The tax advantage diminishes but can still reduce overall household tax liability.
Children 21 and Over
Adult children are treated as regular employees for payroll purposes. While wages remain deductible and retirement contributions are possible, payroll tax exemptions no longer apply.
Spouses
Spouses are subject to standard payroll taxes, although some FUTA exemptions may exist for sole proprietorships. Compensation must be reasonable and tied to actual work, and benefits or retirement eligibility can enhance overall family financial planning.
Parents
Wages paid to parents generally follow standard payroll rules. FUTA exemptions may apply in limited cases depending on business structure and the nature of the work. Proper documentation remains critical.
Best Practices for Hiring Family in Your Business
Following structured best practices ensures that hiring family in your business is compliant and maximizes tax advantages.
- Set Market-Based Wages: Determine pay based on comparable roles in your local market. Document your research and rationale to support IRS compliance.
- Use Real Timesheets and Responsibilities: Track work hours and outcomes just as you would for any employee. Include photos, reports, or production logs to validate the wage deduction.
- Run Payroll Properly: Even if payroll taxes are exempt for minor children, use a payroll system to generate W-2s and maintain formal records. Avoid informal cash payments.
- Align Benefits and Retirement Plans: Ensure eligibility and contributions for benefits and retirement accounts are consistent with non-family employees to maintain compliance.
- Confirm State and Federal Labor Compliance: Check child labor permits, hour limits, minimum wage laws, and other regulations that apply to minors or adult family members. Compliance is essential to protect deductions and avoid fines.
Real-World Scenarios of Hiring Family in Your Business
To make the tax rules more practical, here are some examples showing how hiring family can work in different situations.
Scenario 1: Sole Proprietor Hiring a Teen
A small business owner runs a local bakery as a sole proprietorship. They hire their 16-year-old child to help with packaging orders and social media updates for the summer. They pay the teen $9,500 over three months.
Because it’s a sole proprietorship and the child is under 18, the business does not have to pay Social Security or Medicare taxes on this wage. The teen also likely owes little to no federal income tax because their total income is under the standard deduction. The bakery gets a full deduction for the wages, saving money on taxes while giving the child a paycheck for real work.
Scenario 2: S Corporation Hiring a Teen
An S corporation bakery hires the same 15-year-old for $6,000. This time, payroll taxes, including Social Security and Medicare, apply because corporations do not get the minor-child exemptions. The wages are still deductible for the business, and the teen may still not owe federal income tax, but the overall tax savings are smaller compared to a sole proprietorship. This shows how the type of business entity affects payroll taxes and overall savings when hiring family.
Scenario 3: Spouse as Office Manager
A business owner hires their spouse to manage bookkeeping, invoices, and customer emails, paying $40,000 per year. Wages are deductible for the business, but Social Security, Medicare, and unemployment taxes apply as usual.
The spouse can also participate in employer-sponsored retirement and health benefits. While payroll taxes reduce the immediate savings, the long-term benefits, such as retirement contributions and coverage under health plans, add value to the family’s financial plan.
Scenario 4: Adult Child as Full-Time Employee
A 23-year-old child is hired full-time to help run the marketing and shipping operations of the family business, earning $55,000 per year. Payroll taxes fully apply, and the child is treated like any other employee.
Even though the payroll tax savings are gone, the wages are still deductible for the business, and the child can take advantage of retirement contributions and benefits. This scenario shows that hiring adult children is less about immediate tax savings and more about long-term financial planning and supporting family employment.
Common Questions and Mistakes in Hiring Family in Your Business
Hiring family members is appealing, but there are mistakes that often catch business owners off guard. Understanding these can prevent audits, fines, or lost deductions.
Independent Contractor Misclassification
Sometimes business owners think they can avoid payroll taxes by calling family members contractors. Most family members performing work under the control of the business are employees, not contractors. Misclassifying them can trigger IRS penalties and back taxes. Always use payroll when family members perform regular, controlled tasks.
Paying Children in Non-Wage Forms
Some owners try to pay children with gifts, cash allowances, or tuition support to avoid taxes. The IRS only allows deductions for actual wages paid for real work. Payments disguised as gifts or allowances are not deductible.
S Corporation Limitations
Owners of S corporations cannot claim Social Security and Medicare exemptions for minor children. This is a major difference from sole proprietorships or parent-only partnerships. Planning around entity type is critical if you want to maximize tax benefits.
Overpaying Family Members
The IRS expects wages to be “reasonable,” meaning similar to what you would pay a non-family employee for the same job. Paying too much to shift income to family members can trigger audits and disallow deductions. Always document hours worked and tasks completed and consider writing job descriptions for family employees.
Failing to Track Hours and Work
Even for family members, you must track work hours, duties performed, and payroll. Informal arrangements, like paying a child for “helping out” without timesheets or deliverables, can be challenged by the IRS. Using a payroll system, keeping timesheets, and saving work records reduces the risk of penalties.
Ignoring State Labor Laws
State labor laws still apply, especially for minors. There may be rules on the maximum hours, work permits for children, and minimum wage requirements. Ignoring these rules can result in fines and disallowed deductions. Always check local regulations before hiring family members, particularly teens.
Frequently Asked Questions
What are the tax advantages of hiring family members?
Hiring family members can shift income to lower tax brackets, provide payroll tax exemptions for minor children in sole proprietorships or parent-only partnerships, and allow deductible wages and fringe benefits like retirement contributions and health plans.
Can I pay family from my LLC?
Yes, an LLC can pay family members as employees, but tax rules depend on how the LLC is taxed. Payroll taxes generally apply unless it’s a sole proprietorship or parent-only partnership structure with minor children.
How do I pay family members in a business?
Family members should be paid like any other employee: through payroll, with W-2s, documented hours, and reasonable wages based on the work performed. Fringe benefits and retirement contributions can also be provided.
What is the kiddie tax?
The kiddie tax applies to unearned income, such as interest and dividends, of children under 19 (or under 24 if a full-time student) at their parents’ marginal tax rate. It does not typically apply to wages earned from working in a family business.
How much can kids earn tax-free?
Children can earn up to the standard deduction for earned income without owing federal income tax. For 2025, this is $15,750 for single dependents, though payroll taxes may still apply depending on the business structure.
Can I pay my child in cash from my company?
Paying your child in cash is not recommended for tax purposes. All wages should be processed through payroll with proper documentation, including timesheets and W-2s , to ensure deductions are valid and avoid IRS issues.
Tax Help for Those Hiring Family in Your Business
Hiring family in your business can be a powerful tool for tax planning, household income support, and operational reliability. The benefits are most pronounced for minor children in sole proprietorships or parent-only partnerships but still exist for spouses and adult children through deductions, retirement plans, and benefits. To maximize advantages and minimize risks, document roles, pay reasonable wages, comply with payroll and labor laws, and carefully track hours and deliverables. If ever unsure, be sure to consult a knowledgeable tax professional to avoid IRS audits. Optima Tax Relief is the nation’s leading tax resolution firm with over $3 billion in resolved tax liabilities.
If You Need Tax Help, Contact Us Today for a Free Consultation