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Employing Your Spouse and Children in Your Business

Sep 17, 2018

Employing your spouse and your children in your business is a strategic move that can be an integral character building and learning experience for your child and provide tax benefits to you. A frequent criticism lobbed at many of today’s young people is the perceived lack of an appropriate work ethic. By hiring and employing your children, you get more opportunities to teach them responsibility, goal setting, and the skills they need to meet deadlines and manage expectations.

However, like everything else, there are guidelines that must be followed.

If your business is set up as a sole proprietorship or single member LLC, you can employ your spouse and children. If it is set up as a partnership in which you and your spouse are the sole partners, you can employ your children. Wages paid reduce not only your taxable income, but can reduce self-employment tax that you must pay.  

You cannot add family members to your payroll for the sake of creating a tax deduction. Each employee must have specific duties to perform and put in the necessary hours.

Compensation must be reasonable for the work performed. A reasonable wage is a valid, deductible business expense. Your child or spouse can use their earned wages to purchase clothing, school supplies, and transportation costs, among other things. They can pay directly for those items that you were going to provide for them anyway -- let that sink in! You have just turned expenses that you would have paid on their behalf (had they not received compensation) into a tax-deductible expense. Compensation must be “in-cash” to your family, not “in-kind.” Don’t cut out the middle step by paying expenses directly on their behalf and classifying these payments as compensation. Each employee must have control over the compensation they earn.

Spouse and children employed in your partnership or sole proprietorship are not subject to workers compensation coverage.  In addition, wages paid to your children under the age of 18 are not subject to social security and Medicare taxes, federal unemployment taxes, and generally not subject to state unemployment taxes in these types of entities. You don’t have to issue your child an annual Form W2 – Wage and Tax Statement; however, you may want to issue a W2 if an IRA contribution is going to be made by this employee. 

Compensation paid may have an impact on financial aid for education, so that should be taken into account as well. As always, good recordkeeping is essential.

Please consult your tax advisor to discuss these and other considerations of employing your spouse and children.

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Gaye C. Eschenbach

Gaye Eschenbach is a Senior Manager in the Private Client Services Group assisting many industries including manufacturing, wholesale distribution and real estate with tax planning and review, financial statement compilation and review services.

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