Charles Read, CPA, USTCP, IRSAC
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One of the advantages of operating your own business is hiring family members. However, employment tax requirements for family employees may vary from those that apply to other employees. The following information may assist you in pointing out some differences to consider.
A child employed by parents
Payments for the services of a child under age 18 who works for his or her parent in a trade or business are not subject to Social Security and Medicare taxes if the trade or business is a sole proprietorship or a partnership in which each partner is a parent of the child. Refer to the “Covered services of a child” section below. Payments for the services of a child under age 21 who works for his or her parent in a trade or business are not subject to the Federal Unemployment Tax Act (FUTA) tax. Payment for the services of a child is subject to income tax withholding, regardless of age.
Covered services of a child
The wages for the services of a child are subject to income tax withholding as well as Social Security, Medicare, and FUTA taxes if he or she works for:
- A corporation, even if it is controlled by the child’s parent,
- A partnership, even if the child’s parent is a partner unless each partner is a parent of the child, or
- An estate, even if it is the estate of a deceased parent.
One spouse employed by another
A spouse is considered an employee if there is an employer/employee type of relationship, i.e., the first spouse substantially controls the business in terms of management decisions and the second spouse is under the direction and control of the first spouse. If such a relationship exists, then the second spouse is an employee subject to income tax and FICA (Social Security and Medicare) withholding. However, if the second spouse has an equal say in the affairs of the business, provides substantially equal services to the business, and contributes capital to the business, then a partnership type of relationship exists and the business’s income should be reported on Form 1065, U.S. Return of Partnership Income (PDF).
Both spouses carry on the trade or business
On May 25, 2007, the Small Business and Work Opportunity Tax Act of 2007 was signed into law and affected changes to the treatment of qualified joint ventures of married couples not treated as partnerships. The provision is effective for taxable years beginning after December 31, 2006.
The provision generally permits a qualified joint venture whose only members are a married couple filing a joint return not to be treated as a partnership for Federal tax purposes. A qualified joint venture is a joint venture involving the conduct of a trade or business, if (1) the only members of the joint venture are a married couple who file a joint tax return, (2) both spouses materially participate in the trade or business, (3) both spouses elect to have the provision apply, and the business is co-owned by both spouses and (4) isn’t held in the name of a state law entity such as a partnership or limited liability company (LLC).
Under the provision, a qualified joint venture conducted by a married couple who file a joint return is not treated as a partnership for Federal tax purposes. All items of income, gain, loss, deduction, and credit are divided between the spouses in accordance with their respective interests in the venture. Each spouse takes into account his or her respective share of these items as a sole proprietor. Thus, it is anticipated that each spouse would account for his or her respective share on the appropriate form, such as Schedule C. For purposes of determining net earnings from self-employment, each spouse’s share of income or loss from a qualified joint venture is taken into account, just as it is for Federal income tax purposes under the provision (i.e., in accordance with their respective interests in the venture).
This generally does not increase the total tax on the return, but it does give each spouse credit for Social Security earnings on which retirement benefits are based. However, this may not be true if either spouse exceeds the Social Security tax limitation. Refer to Publication 334, Tax Guide for Small Business, for further information about self-employment taxes. For more information on qualified joint ventures, refer to Election for Married Couples Unincorporated Businesses.
Parent employed by child
The wages for the services of a parent employed by his or her child in a trade or business are subject to income tax withholding and Social Security and Medicare taxes. Wages paid to a parent employed by his or her child are not subject to FUTA tax, regardless of the type of services provided. For additional employment tax information, refer to Publication 15, Circular E, Employer’s Tax Guide, and Publication 51, Circular A, Agricultural Employer’s Tax Guide.
If your parent works for you in your business, the wages you pay to him or her are subject to income tax withholding and Social Security and Medicare taxes. Social Security and Medicare taxes do not apply to wages paid to your parent for services not performed in your business, but they do apply to domestic services if all the following apply:
- You employ your parent;
- You have a child or stepchild living in the home;
- You are a widow or widower, divorced, or living with a spouse, who because of a mental or physical condition, can’t care for the child or stepchild for at least 4 continuous weeks in a calendar quarter; and
- The child or stepchild is either under age 18 or requires the personal care of an adult for at least 4 continuous weeks in a calendar quarter due to a mental or physical condition.
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