Here’s what HIVE AI had to say about “Can I pay my children or spouse through the business?”:
Yes, you can pay your children or spouse through the business, but there are specific rules and requirements that must be followed to ensure the payments are legitimate business expenses and comply with employment tax obligations.
Paying Your Children Through the Business
Age-Based Employment Tax Rules
The employment tax treatment of payments to your children depends on their age and the nature of your business structure. FICA must be paid on services performed by: A child who is 18 or older employed by a parent in the course of the parent’s business, and a child who is 21 or older employed by a parent, whether or not in the course of the parent’s business. IRS IRM 21.7.2 Employment and Railroad Tax Returns IRS IRM 21.7.2 Employment and Railroad Tax Returns
For younger children, the rules are more favorable. If these payments are for work other than in a trade or business, such as domestic work in the parent’s private home, they’re not subject to social security and Medicare taxes until the child reaches age 21. Payments for the services of a child under age 21 who works for their parent, whether or not in a trade or business, aren’t subject to FUTA tax. IRS – Publication 15: Circular E, Employer’s Tax Guide IRS – Publication 15: Circular E, Employer’s Tax Guide
However, income tax withholding generally applies regardless of age. Payments for the services of a child of any age who works for their parent are generally subject to income tax withholding unless the payments are for domestic work in the parent’s home, or unless the payments are for work other than in a trade or business and are less than $50 in the quarter or the child isn’t regularly employed to do such work. IRS – Publication 15: Circular E, Employer’s Tax Guide
Business Structure Considerations
The employment tax exemptions for family members only apply to certain business structures. The wages for the services of a child or spouse are subject to income tax withholding as well as social security, Medicare, and FUTA taxes if they work for: A corporation, even if it is controlled by the child’s parent or the individual’s spouse; A partnership, even if the child’s parent is a partner, unless each partner is a parent of the child; A partnership, even if the individual’s spouse is a partner; or An estate, even if it is the estate of a deceased parent. In these situations, the child or spouse is considered to work for the corporation, partnership, or estate, not you. IRS – Publication 15: Circular E, Employer’s Tax Guide
Legitimacy Requirements
The most critical requirement is that the work performed must be legitimate and the compensation reasonable. A normal supposition when payments are made to dependent children or when items are purchased by a parent for dependant children is that the money or items are in the nature of support and nondeductible. However, a payment made to minor children by a parent for services rendered in connection with the parent’s trade or business might very well qualify as a business expense deduction. Dawson U.S. Tax Court Opinions: Embroidery Express, LLC Dawson U.S. Tax Court Opinions: Embroidery Express, LLC
Family members may work as employees of the business if bona fide services are performed. It is recommended for family member that the provider keeps a record of the dates, time, compensation rates, and work performed that clearly establishes the business purpose and to establish the bona fide service aspect. IRS – Publication 5603: Child Care Provider Audit Technique Guide
Documentation and Reasonableness Standards
Courts scrutinize family employment arrangements carefully. In one case, the Tax Court found problems with a family employment arrangement where petitioners placed little economic value on the jobs their children completed throughout the year but paid them significant bonuses at yearend, partially on the basis of the performance of petitioners’ embroidery business. Although Mr. McMinn testified that he paid the children on the basis of what he would pay an unrelated party, petitioners introduced no evidence proving that an unrelated party would receive a similar bonus for the same work. The bonuses were the largest part of the children’s wages and were paid at yearend after petitioners had the opportunity to determine the financial status of the business. Dawson U.S. Tax Court Opinions: Embroidery Express, LLC
Another case illustrates the importance of proper documentation and legitimate business purposes. Petitioner testified that after reading IRS Publication 334, Tax Guide for Small Business, she came up with the idea of paying her children to perform services, including business development, as an indirect expense of her business. She testified that “I had an agreement with them that * * * in exchange for providing them a place to live and, yes, some of their personal expenses and their educational expenses, that they would work as an administrative capacity supporting myself in the small business.” The items paid for included a townhouse and vehicles in Florida and apparently all of the students’ meals, clothing, travel, and entertainment–ifthe list in petitioner’s summary is accurate. Although petitioner denied deducting all of her student children’s living, education, and entertainment expenses, without detail as to the summarized expenses it is impossible to separate personal expenses from business expenses, if any, or to see what portion of total family expenses, beyond the 50% reduction of $42,062.24 for meals and entertainment, petitioner deducted on Schedule C. Dawson U.S. Tax Court Opinions: Harlan Wax & Deborah J. Wax Dawson U.S. Tax Court Opinions: Harlan Wax & Deborah J. Wax
Paying Your Spouse Through the Business
Employment Tax Treatment
FICA must be paid on services performed by a spouse in the course of the employer spouse’s trade or business. IRS IRM 21.7.2 Employment and Railroad Tax Returns More specifically, services of an individual who works for their spouse in a trade or business are subject to income tax withholding and social security and Medicare taxes, but not to FUTA tax. However, the payments for services of one spouse employed by another in other than a trade or business, such as domestic service in a private home, aren’t subject to social security, Medicare, and FUTA taxes. IRS – Publication 15: Circular E, Employer’s Tax Guide
Business Structure Impact
Similar to children, the business structure affects the employment tax treatment of spousal payments. The same corporate and partnership rules apply where spouses working for these entities are treated as regular employees subject to all employment taxes.
Community Property Considerations
In community property states, special rules may apply. If you and your spouse jointly own and operate an unincorporated business and share in the profits and losses, you are partners in a partnership, whether or not you have a formal partnership agreement. If you and your spouse wholly own an unincorporated business as community property under the community property laws of a state, foreign country, or U.S. possession, you can treat the business either as a sole proprietorship or a partnership. IRS – Publication 583: Starting a Business and Keeping Records IRS – Publication 583: Starting a Business and Keeping Records
Tax Reporting Implications
Income Attribution for Children
When children earn income from working in the family business, specific tax rules apply. All expenditures by the parent or the child attributable to amounts which are includible in the gross income of the child (and not of the parent) solely by reason of subsection (a) shall be treated as paid or incurred by the child. IRC § 73(b) This means that all expenditures made by the parent or the child attributable to amounts which are includible in the gross income of the child and not of the parent solely by reason of section 73 are deemed to have been paid or incurred by the child. In such determination, the child is entitled to take deductions not only for expenditures made on his behalf by his parent which would be commonly considered as business expenses, but also for other expenditures such as charitable contributions made by the parent in the name of the child and out of the child’s earnings. Tresuary Reg. Treasury Regulation None
Record-Keeping Requirements
Proper documentation is essential for family employment arrangements. You should maintain detailed records including:
- Job descriptions and duties performed
- Hours worked and dates of service
- Compensation rates and payment schedules
- Evidence that the work serves a legitimate business purpose
- Documentation showing the compensation is reasonable for the services provided
Best Practices for Family Employment
To ensure compliance and maximize the benefits of employing family members:
Establish Legitimate Job Duties: Create real job descriptions with meaningful responsibilities that serve genuine business needs.
Pay Reasonable Compensation: Research market rates for similar work and ensure compensation aligns with the value of services provided.
Maintain Regular Payment Schedules: Avoid large year-end bonuses that appear to be based on business profits rather than work performed.
Document Everything: Keep detailed records of work performed, hours worked, and business justification for the employment.
Separate Business and Personal: Ensure payments are for legitimate business services, not disguised personal support or family expenses.
Follow Employment Tax Rules: Comply with all applicable withholding and reporting requirements based on the family member’s age and your business structure.
Consider Retirement Benefits: Family employees can participate in qualified retirement plans, potentially providing additional tax benefits.
Employing family members can provide legitimate tax benefits while helping family members earn income and gain business experience. However, the arrangements must be structured properly with genuine business purposes, reasonable compensation, and proper documentation to withstand IRS scrutiny.
Sources
- IRS IRM 21.7.2 Employment and Railroad Tax Returns
- IRS – Publication 15: Circular E, Employer’s Tax Guide
- IRS – Publication 583: Starting a Business and Keeping Records
- IRS – Publication 5603: Child Care Provider Audit Technique Guide
- IRC § 73(b)
- Treasury Regulation 1.73-1
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