How a Family Business Pays Taxes
Family Business
Help and Rules
On this page
- Introduction
- Owning a Family Business: Overview
- 2.1 Paying Reasonable Wages for Legitimate Work
- Tax Implications of Owning a Family Business
- 3.1 Family Business Structure and Taxation
- 3.2 Tax Considerations for Child Dependents
- 3.3 Tax Considerations for Adult Dependents, Relatives
- 3.4 Self-Employment Taxes and Schedule SE
- Conclusion
Hiring Dependents
Businesses take on many forms; if you own a small or large business and are looking to learn about the tax implications of hiring family members, this page answers your questions. When it comes time to file, give the eFile Tax App a try and see how much you can save on your tax preparation fees.
1. Introduction
Owning a family business can be a rewarding endeavor, providing not only financial stability but also a sense of legacy and continuity. However, along with the benefits come various responsibilities, including understanding the intricate tax implications that come with running a family enterprise. On this page, we explore how owning a family business affects taxes, including considerations for child and adult dependents, as well as the impact of self-employment taxes.
See more details in IRS Publication 15, Employers Tax Guide, and find section 3, Family Employees.
2. Owning a Family Business: Overview
A family business is one in which one or more family members are involved in its operation and ownership. These businesses can range from small, mom-and-pop shops to large corporations with multiple generations working together. Family businesses often have unique dynamics, as decisions are not only driven by financial considerations but also by familial relationships and long-term goals.
The state of your business determines how you pay taxes and which tax breaks are available to you. You may be a sole proprietor or involved in a partnership for your business of it may be a corporation or estate. In each case, different taxes are applied.
We at eFile.com make taxes simple for individual income tax returns; if you (and your spouse) own a business or a considered self-employed, then you generally will file an individual income tax return via Form 1040 as single, head of household, married, or as a qualifying surviving spouse. With this return, you will include your business income on Schedule C and Schedule SE; all your forms are generated by the eFile Tax App so you do not need to fill out these complicated IRS forms.
2.1 Paying Reasonable Wages for Legitimate Work
When hiring or employing your child to work, it is important that they must perform genuine tasks while on the clock and receive a fair wage for those services. This is an IRS rule which prevents businesses and parents from taking advantage of tax savings by having their child perform illegitimate work around the business. For example, you would not be able to say your twelve-year-old works for you if they enjoy dusting around the office and talking to clients to keep them entertained. Your young employee must perform tasks that benefit the business and keep the workflow moving.
In addition, wages paid for these services must be reasonable. Any pay should be similar to what you would pay to a non-child or non-dependent. Keep accurate records of your employees, their job descriptions, and their pay in order to keep in line with the IRS.
3. Tax Implications of Owning a Family Business
3.1 Family Business Structure and Taxation
The structure of a family business significantly influences its tax obligations. Common structures include sole proprietorships (one owner), partnerships (two owners), S-corporations, and limited liability companies (LLCs). Each structure has its own tax implications, including how profits are taxed, deductions are claimed, and liabilities are distributed among family members.
We are focused on sole proprietors and partnerships where both partners are married or parents here. If you (and your spouse) operate your business as such and pay individual self-employment taxes, we have the app for you!
Consider these simple tips when it comes to your business to take control of your taxes and even save some money:
3.2 Tax Considerations for Child Dependents
Children (here meaning any dependent under age 18) who are employed by their family business may have different tax obligations depending on their age and level of income. For example, if a child is under the age of 18 and works for a family business, their earned income may be subject to different tax rates than those applicable to adults and their standard deduction is generally lower. Additionally, employing children in a family business can provide tax benefits for the parents, such as deducting their children's wages as a business expense.
If your business is a sole proprietorship or a partnership (where both partners are parents of the child), then payments for services of your dependent under age 18 are not subject to Social Security or Medicare taxes (Federal Insurance Contributions Act or FICA). If they are under 21, then these payments are not subject to Federal Unemployment Act taxes (FUTA). This is a significant way to save money on taxes.
Creating a family business is a great way to build your family up, but it is also a highly effective way to save money on wages and other expenses.
3.3 Tax Considerations for Adult Dependents, Relatives
Adult dependents working in a family business are subject to standard tax obligations based on their income level, regardless of their relationship to the business owners. However, adult children that are not claimed as your dependent may be eligible for certain tax deductions and credits, such as the Earned Income Tax Credit (EITC) or education-related deductions, depending on their individual circumstances.
Consider the following examples:
- Your 21-year-old son boards at a college during the year, but returns home in the summer to work for your business. You may determine if you wish to claim them as a dependent or not - see this free dependent tool - but most college students are not dependents since they leave home and pay for most of their expenses, often through student loans. In this case, you would not claim them, so they would file a return to claim their income towards the EITC.
- On the other hand, if your college student lets you claim them as a dependent, likely due to you providing their financial support while they are away from home as a temporary absence, then you can generally claim an education tax credit for them and may qualify for the EITC depending on other factors.
- Calculate the EITC now.
- You employ your 32-year-old son to work full-time at your business. Due to his age and income, you will not be claiming him as a dependent and there is no way to deduct or reduce taxes on his wage payments.
- Your 16-year-old daughter wants to learn to run the cash register for your business. She works one weeknight after school and one weekend, earning a fair wage for her services to be paid regularly. As her parent(s) and business owner(s), you can write off the wages paid and you should not pay FICA or FUTA taxes on these wages. Your daughter will likely not need to file a return since she is working minimal hours, so you should not withhold taxes from her pay.
3.4 Hiring Your Parents to Work for You
In the tax world, there are no real significant benefits nor any savings to take advantage of when hiring your parents, aunt, uncle, or other older relative to work for you. Consider the following when setting up your family business.
Parents often bring trust and loyalty to the business - they want to see their kids succeed! Their vested interest in your success can foster a strong foundation of commitment and dedication. With shared values and familial ties, parents may inherently understand your business goals and vision, making alignment and collaboration more seamless.
Additionally, adult relatives typically possess a wealth of life experience and possibly industry-specific knowledge that can be invaluable to your business's growth and development. Consider hiring a family member who you know has experience in something that can help your business.
3.5 Self-Employment Taxes and Schedule SE
Self-employment taxes are applicable to individuals who work for themselves, including owners of family businesses. These taxes cover Social Security and Medicare contributions that would typically be withheld by an employer in a traditional employment setting. Family business owners are required to report and pay self-employment taxes on their income, which is calculated using Schedule SE (Form 1040) - eFileIT. It's essential for family business owners to understand their self-employment tax obligations to avoid penalties and maintain compliance with the Internal Revenue Service (IRS).
Not sure what taxes you may owe? Estimate your return for free or contact us for human support on your tax questions. eFile handles Schedule SE, Schedule C, Form 1040, and other required IRS forms. State returns can be prepared and e-filed with your return with ease.
4. Conclusion
Owning a family business brings about both opportunities and challenges, like figuring out the complex landscape of taxation. By understanding the tax implications of owning a family business, including considerations for child and adult dependents as well as self-employment taxes, business owners can make informed decisions to optimize their financial outcomes and ensure compliance with tax laws.
We offer free human support when it comes to your taxes - sign up now and file your business return to the IRS plus applicable state income tax returns. Don't get lost in tax mumbo jumbo - make IT less taxing on eFile.com. IT is Income Taxes.
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