Relatively speaking, family employees are good business
Psst. Want to lower your taxes, lure great employees,
save more for the future and make your small business deliver a
bigger bang for your whole household?
Hire the family.
What's the catch? There isn't one.
Hiring your spouse and kids is A-OK with the Internal
Revenue Service. And if done with some forethought, it can contribute
big time to both your family's financial health and your business's
This is welcome news to the increasing number of Americans
migrating to self-employment. Usually, they receive the bad news
first: those many and sundry ways in which the little guy pays proportionately
more for everything while the corporate giants pay proportionately
less. Hiring the family may not exactly level the playing field,
but it is something you can do legally that a corporation cannot.
Got your attention? Good. Here's the lowdown on why
and how you should hire your family, today if possible.
The way it used to be
First step: check your attitude.
Squeamish about putting the kids on the payroll? Don't
be, says Jane Hilbert Davis, executive director of the Cambridge
Center for Creative Enterprise and chair of the Family Firm Institute.
"It's only been within the last century that
most kids didn't work with their families, whether it was on the
family farm or as an apprentice to their dads. Women worked with
their moms," she says. "The kids did learn from both parents
about responsibility and commitments and hanging in there when the
going gets tough. I think family businesses are a way to capture
that and teach it."
But family workers shouldn't be free employees. Presuming
you have valid work for your spouse or kids, it's in your best interest
to pay them a fair wage for it, says Craig Aronoff, co-chairman
of the Family
Business Consulting Group and founder-director of the Cox Family
Enterprise Center at Kennesaw State University in Kennesaw, Ga.
"There is a tendency to use family members in
a way that kind of exploits them," he says. "The wife
who comes in and keeps the books and doesn't receive any compensation,
for example, would be a situation like that. If you're bringing
someone in to do a job, then compensating them and recognizing their
value in the same way as other employees is very important."
If you heed the advice of family counselors on how
with your spouse and separate
your work life from your home life, bringing the family into
the business could be the best thing you ever did.
The business case for employing
Hiring the family makes sound business sense for a number of reasons:
- Operations: Family
members can be a ready source of dedicated, trusted and inexpensive
labor during your startup phase. They'll be more inclined to
work odd hours, take up the slack and cheer you on as needed.
They'll also be better prepared to succeed you.
- Payroll: If you're
a sole proprietor, or if you and your spouse are the only principals
in a partnership or limited
liability company, you may save on some federal income taxes
and state unemployment taxes. If you hire your children, you are
relieved from withholding income taxes and paying payroll taxes,
including Social Security, until the child turns 18. Also, you
need not pay federal unemployment taxes until the child turns
21. If you hire your spouse or parents, you don't need to pay
federal unemployment taxes on them either, though you must withhold
federal income tax and pay FICA on them. Corporations are not
allowed these tax breaks.
- Income Splitting:
Spreading income over several family members increases the amount
that is taxed at the lower tax brackets. This is especially true
when hiring your children. Last year, you could have paid a child
up to $4,700 without either of you incurring a tax liability.
A child's earning limit is adjusted annually for inflation, and
mirrors the standard deduction amount for a single filer. (Your
child may have to file a return, if he or she has investment income
as well as wages.) Plus, you can deduct the compensation as a
business expense, thus taking it off of your gross income. The
same holds true for older parents who are in a lower tax bracket
than you. Just make sure the compensation is reasonable for the
- Insurance: You can
save plenty on health insurance and other benefits when you cover
your family as employees. Not only will you qualify for broader
plans at better rates, but you can write off the total cost of
coverage as a business expense (vs. the 70 percent the feds currently
allow the self-employed) and establish a tax-deductible reimbursement
plan to write off medical expenses not covered by insurance.
- Child care: Uncle
Sam allows you a maximum $4,800 credit
for child care costs. Why not hire your spouse and pay him
or her the full amount of your child care as a fringe benefit?
That way, you can deduct the total as a business expense and it's
nontaxable to your spouse.
- Savings Programs:
Once a child earns wages, they can establish an Individual Retirement
Account, meaning they can tuck away $3,000 (or as much as they
earn if it's less than that) in a tax-deferred account. Consider
IRA if the kids are likely to want to tap their account early,
say for college or a first home. Since taxes are already paid
on money put into a Roth, there will be no tax due if it's taken
out early, penalty-free, for IRS-allowable expenses. Even if they
don't use the money before retiring, the long-term tax advantages
of Roth are usually better for younger savers since all distributions
can be taken out tax-free after age 59½.
- Social Security: Because
a survivor's benefits under Social Security are only half the
decedent spouse's benefits, it's a good idea to build up each
spouse's Social Security earnings. Hiring a spouse, especially
a non-working one, helps achieve this goal.
Tax-smart family hires
The IRS is generally encouraging to family hiring if you follow
The easiest way to flag the taxman is to pay an inordinate
amount or pay for a fictitious job or compensate a family member
who clearly could not perform the task. In addition, the money you
pay them must be in their control. Otherwise, it's still considered
That's the long way of saying be prepared with documentation
in case you're audited,
or your family's incomes could boomerang right back onto your gross,
at your tax bracket.
"The key is to be very upfront, be very businesslike,"
Aronoff advises. "If it's going to be business, it needs to
be business. And the rules and procedures and policies need to be
established and everybody needs to be clear about them. If not,
there is a high probability that these things will lead to additional
Davis suggests that you actually interview your family
hires as if they were non-relatives. Discuss what the job entails,
short- and long-term goals, a pay range based on industry standards.
Then draw up a written contract setting out what you've both agreed
to. In addition, because you're family, it's important to agree
upon exit strategies (should either side want out) and a means of
"Even if the IRS isn't as stringent with family
businesses, I think it's really important for families to be, both
in teaching the next generation and learning themselves how to settle
things in a fair way and make arrangements between family members
where money and work are concerned," she says.
"Informality is fine, but you should never be
informal where business practices are concerned. They should be
Jay MacDonald is a contributing editor
based in Florida.
-- Updated: Jan. 22, 2003